The Structure of Stockholder Litigation: When do the Merits

This Article investigates a question that has preoccupied corporate law scholarship for nearly 75 years: Do the merits matter in stockholder litigation? We exploit variation in the remedies available to stockholders at merger to show that classic stockholder litigation seems driven largely by factors unrelated to legal merit. Two unique features make the merger setting an especially apt setting to study this question. First, in merger litigation, the merits of the legal claims are uniquely easy to perceive. Prior work has relied on proxies for litigation merit — the presence of an accounting restatement, a parallel SEC inquiry, and so forth. A merger, however, is an end-period transaction, and the only issue of genuine consequence to a typical stockholder will be the adequacy of the merger consideration. The second unique advantage of studying mergers is that stockholders have two distinct types of legal remedies available to them — filing a class action alleging fiduciary breach or seeking stockholder appraisal. The fiduciary class action shares the same basic structure as other forms of stockholder litigation like federal securities suits and derivative claims: a class comprised of all shareholders, lead plaintiffs with small holdings, and plaintiffs’ attorneys who control of the claims. Appraisal litigation, by contrast, has none of these features. If the fiduciary class actions differ from appraisal in the incidence and intensity of litigation, we can thus conclude that the difference is attributable to the difference in structure. We analyze over 1,000 mergers from 2004 through 2013, investigating what factors are associated with fiduciary class actions and with appraisal filings. Fiduciary duty class actions challenging mergers are strongly associated with deal size, a variable that has far greater explanatory power than the merger premium. Our findings suggest that the merits count for little in the decision to bring a fiduciary suit and that such suits are brought for their nuisance value. By contrast, appraisal claims appear strongly related to legal merit. We argue that this difference demonstrates that litigation structure has a marked effect on the merits of claims. We also sketch out some preliminary reforms designed to restructure conventional stockholder litigation in ways that will reduce meritless claims and improve the incentive to prosecute strong claims