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Makes Sense to Me

I have always thought the logic of shareholder law suits were crazy to start with, and even crazier given that shareholder suits over loss of stock value tend to result in ... declining stock value.

I have never been able to justify most lawsuits by shareholders against companies in which they own shares.  Any successful verdict would effectively come out of the pockets of the company's owners who are.. the shareholders.  So in effect, shareholders are suing themselves, and, win or lose, they as a group end up with less than if the suit had never been started, since a good chunk of the payout goes to the lawyers.  The only way these suits make financial sense (except to the lawyers, like Bill Lerach) is if only a small subset of the shareholders participate, and then these are just vehicles for transferring money from half the shareholders to the other half, or in other words from one wronged party that does not engage in litigation to another wronged party who are aggressively litigious.  Is there really justice here?

OK, you could argue that many of these shareholders are not suing themselves, because they are past shareholders that dumped their stock at a loss.  But given these facts, these suits are even less fair.  If these suits are often made by past shareholders who held stock at the time certain wrongs were committed, they are paid by current and future shareholders, who may well have not even owned the company at the time of the abuses, and may in fact be participating in cleaning the company up.  So their argument is that because the company was run unethically when I owned it, I am going to sue the people who bought it from me and cleaned it up for my damages?  Though it never happens, the more fair approach would be for current shareholders to sue past shareholders for the mess they left.

Tom Kirkendall quotes a related notion from the Economist:

This suggests to The Economist the need for a new Apple rule to guide prosecutors—at least in cases, such as backdating, where the main supposed victim is a company’s shareholders. Our rule: if a criminal prosecution is likely to hurt a company’s share price, then don’t prosecute.

Are we serious? Well, we think it's worth a discussion . . . Cost-benefit analysis is largely absent from America’s approach to regulating business wrongdoing, not only in criminal prosecutions, and that is probably one of the main reasons why America’s capital markets are indeed losing their competitive edge. At the very least, encouraging the Department of Justice and the Securities and Exchange Commission to employ a few less lawyers and a few more economists would be a step in the right direction.

Posted on March 14, 2007 at 09:21 AM | Permalink


Can the shareholders sue the management team that's running the company and the board of directors personally?

Posted by: Garble | Mar 15, 2007 3:40:26 AM

I guess I don't see why shareholder suits don't make sense. You own part of a company when you own stock. That company is run by other people, who owe you a duty to use due care in their actions as employees to you, who are an owner. The board of a company, in addition to owing you the duty of due care as the owner, owes a fiduciary duty to you as the owner, because they are tasked with managing something you own for your benefit, and they are being compensated for it.

A coroporation can only act through its employees, so when its employees act improperly, the company is acting improperly. When someone acts improperly towards you and causes you damage, you sue who or whatever acted improperly. (You could also try to sue people individually, expecially if they breached their fiducuary duty to you. However this is a lot harder to prove than mere negligence, and the people aren't as rich as the company.) Whether or not people think its "fair" is a completely moral and subjective opinion.

That you are suing something you have an ownership interest in makes no difference, you can sue the government, which you also have an ownership interest in, or you can sue Coca Cola if their truck runs you over, even if you own Coca Cola stock. The bottom line is somebody injured you or your property rights, and you can be compensated.

It must makes some sense to people other than the lawyers, or else why would poeple do it? The plaintiffs are acting in their own self-interest, and enforcing their rights as oppossed to waiting for the government to rescue them for their investment choices. If a jury finds that the owner's wrongful acts are worse than those of the employees or the board, then the shareholders won't be able to recover. Most likely it will settle, because litigation is expensive. However, that is the cost of having well-defined property rights and a system to enforce them.

Posted by: Bill | Mar 15, 2007 3:57:47 PM

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