Shareholder Lawsuits: Where is the Line between Legitimate and Frivolous?

Larcker, David F. and Tayan, Brian, Shareholder Lawsuits: Where is the Line between Legitimate and Frivolous? (November 27, 2012). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance and Leadership No. CGRP- 29. Available on SSRN. Shareholders of public companies are not responsible for designing executive compensation packages. Still, a shareholder vote on compensation is required in two circumstances: when a company wants to establish an equity-based compensation plan, and annually as part of the Dodd Frank requirement shareholders have an advisory “say on pay.” In deciding how to vote, shareholders rely on information provided in the annual proxy.

Recently, shareholder groups have sued companies for inadequate disclosure. They allege that the companies provide insufficient disclosure to determine how they should vote on these matters.

In one such case against Microsoft, the firm alleges that the company’s proxy is “materially misleading and incomplete” and that directors “violated fiduciary duties of care, loyalty, candor, and good faith… and have acted to potentially put their personal interests ahead of the interests of Microsoft shareholders.”

Main points from the paper:

  1. The shareholder disclosure lawsuit against Microsoft alleges that the company’s proxy is “materially misleading and incomplete.” However, the deficiencies identified by the plaintiffs in Exhibit 3 include information that is often considered proprietary and extreme in its detail. How much disclosure is too much disclosure? If a company follows SEC guidelines, why is this not sufficient?
  2. The Microsoft lawsuit calls for the release of the report prepared by the compensation consultant and all internal memos regarding discussions about executive compensation. Are there any other board decisions that have this level of disclosure? Would the release of this information improve shareholder judgment about the quality of the board’s decision on compensation?
  3. Shareholder lawsuits against a company are an important mechanism in corporate governance. The threat of lawsuit provides strict incentive to directors to fulfill their fiduciary duty. At the same time, frivolous lawsuits impose an unnecessary cost on the corporation and its shareholders because they must be defended without any corresponding improvement in governance quality. When do lawsuits cross the line from legitimate to frivolous?
  4. If compensation litigation alleging misconduct by the board of directors is successful, what other board decisions would be subject to potential suits?

Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences.

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