The Effects of Independent Director Litigation Risk
57 Pages Posted: 12 Nov 2019 Last revised: 2 Sep 2021
Date Written: October 1, 2019
The unexpected In re Investors Bancorp decision in 2017 by the Delaware Supreme Court lowered the liability threshold only for directors in derivative litigation over their own equity grants, increasing their future litigation risk. Investors and firms reacted to the decision. First, Delaware firms experienced significant negative short-window returns, concentrated in high litigation risk firms where equity compensation is most important. Second, Delaware firms responded by increasing the use of director compensation caps, highlighting that they did not pay excessive amounts. Third, Delaware firms with higher abnormal compensation decreased director compensation, while those with lower abnormal compensation did not. Finally, Delaware firms added higher-quality directors to the compensation committee, consistent with concerns about heightened litigation risk for those positions. Notably, these new, higher-quality directors did not accept lower pay, unlike holdover directors who previously served on the committee. Overall, results are consistent with director litigation concerns having a significant effect on shareholder value and firm and director behavior.
Keywords: Director Labor Market; Derivative Litigation; Board Composition; Director Compensation; Litigation Risk; Entire Fairness Standard
JEL Classification: G30, G32, J3, K22, K41, M12, M52
Suggested Citation: Suggested Citation