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Many theoretical and empirical papers address the monitoring mechanisms that
shareholders engage in to ensure that managers represent their interests. Some mechanisms to monitor
the managers have large shareholders (Schleifer and Vishny, 1986), effective boards of
directors (Fama and Jensen, 1983), executive stock ownership (Jensen and Meckling, 1976), etc.
However, one area that has been studied relatively little is shareholder
litigation. Shareholders can sue managers for breach of their fiduciary duties to them,
inaccurate disclosure, fraud-on-the-market, etc. Shareholders resort to litigation when
corporate governance has failed to represent their interests and resolve their grievances. Thus,
it represents the ultimate failure of governance and the ultimate expression of
shareholder activism. Shareholders have been suing with increasing frequency in recent years. Ever
since the corporate scandal of Enron, corporate failures have been receiving increased
media attention. The Sarbanes-Oxley Act, passed by the Congress in 2002, devised new rules
for corporate governance and litigation.
Shareholder litigation is directly linked to corporate governance. Since litigation is the
result of governance failure, good governance should be associated with less shareholder
litigation and bad governance with more litigation. If managers genuinely represent
shareholders' interests (which is the goal of good governance), shareholders would not have a reason to
sue. It is when managers fail in their duties to the shareholders that the latter sue the former.
Thus, it is an interesting empirical question whether good corporate governance results in
less litigation and vice versa. No study seems to have sufficiently answered this question in a
large representative sample. |
