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Griffith, Sean J. --- "D & O Insurance and the Ability of Shareholder Litigation to Deter" [2012] ELECD 473; in Hill, A. Claire; McDonnell, H. Brett (eds), "Research Handbook on the Economics of Corporate Law" (Edward Elgar Publishing, 2012)

Book Title: Research Handbook on the Economics of Corporate Law

Editor(s): Hill, A. Claire; McDonnell, H. Brett

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781848449589

Section: Chapter 18

Section Title: D & O Insurance and the Ability of Shareholder Litigation to Deter

Author(s): Griffith, Sean J.

Number of pages: 15

Extract:

18. D&O insurance and the ability of shareholder
litigation to deter
Sean J. Griffith



1. SHAREHOLDER LITIGATION AND DETERRENCE

Deterrence is widely recognized by legal scholars as the principal policy justification for
shareholder litigation. Arguments in favor of the alternative, the compensation rationale, have
been more or less dispatched, at least as regards the paradigmatic form of shareholder litiga-
tion, the 10b-5 class action, on the basis that damages awards provide meager compensation
relative to investor loss and, from the perspective of diversified shareholders, amount to mere
pocket-shifting.1 Instead, much shareholder litigation is justified wholly by its ability to cause
corporate officers and directors, out of fear of being held liable to their shareholders, to
foreswear bad acts ­ by its ability, that is, to deter.
A significant problem with the deterrence rationale, however, lies in the fact that individ-
ual directors and officers are almost never made to pay for the consequences of their actions
(Black et al. 2006). Nor, indeed, are the corporations they manage. Instead, an insurance
policy typically steps in to fund losses arising from shareholder litigation. This form of insur-
ance ­ Directors' and Officers' Liability Insurance or, simply, `D&O' insurance ­ is
purchased by virtually all public corporations in the United States in amounts sufficient to
fund the vast majority of shareholder settlements. Moreover, most D&O policies cover indi-
vidual directors and officers as well as the corporate entity they manage.
D&O insurance thus transfers the risk of shareholder litigation ...