Incentive Structures for Class Action Lawyers

Abstract

This paper examines the way in which an attorney fee structure that maximizes the expected recovery for class members in a class action may be implemented in practice. Using a mechanism design approach we demonstrate that if the court can observe the lawyer's effort, then the optimal payoff to the class may be realized using the lodestar method - a contingent hourly fee arrangement which is currently practiced in many class actions - but only if the hourly contingent fee is multiplied by a declining, as opposed to the practiced constant, multiplier. If the court cannot observe the lawyer's effort, then in some circumstances, the optimal payoff to the class may still be realized by offering the lawyer a menu of fee schedules from which she has to choose one. Each fee schedule consists of a fixed percentage and a threshold amount below which the lawyer earns no fee, with the threshold increasing with the chosen percentage. The lawyer is paid the fixed percentage chosen only for amounts won above the threshold.

Keywords: class action, attorney fees, lodestar, percentage fees, contingent fees, litigation

JEL Classification: D82, K41