Litigation Risk and the Independent Director Labor Market
45 Pages Posted: 12 Nov 2019 Last revised: 8 Jan 2020
Date Written: October 1, 2019
Does litigation risk affect board composition and compensation-related issues for independent directors? We exploit an unexpected decision by the Delaware Supreme Court, which lowered the liability threshold only for directors in derivative litigation over their own compensation to answer this question. We find that the market, firms and directors all reacted to this rare increase in director-only litigation risk. First, Delaware firms experienced significant negative short-window returns, concentrated in firms with high return volatility (higher litigation risk firms), where equity compensation is most important. These results are consistent with investor concerns about attracting and/or retaining qualified directors. Further, higher risk Delaware firms added more qualified directors to the compensation committee. In contrast, lower risk Delaware firms decreased director equity compensation and their directors decreased insider trading activity. Overall, results are consistent with firms and directors acting to mitigate litigation concerns.
Keywords: Director Labor Market, Derivative Litigation, Board Composition, Director Compensation, Insider Trading, Litigation Risk, Entire Fairness Standard
JEL Classification: G30, G32, J3, K22, K41, M12, M52
Suggested Citation: Suggested Citation