Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform

Shareholder litigation challenging corporate mergers is ubiquitous, with the likelihood of a shareholder suit exceeding 90%. The value of this litigation, however, is questionable. The vast majority of merger cases settle for nothing more than supplemental disclosures in the merger proxy statement. The attorneys that bring these lawsuits are compensated for their efforts with a court-awarded fee. This leads critics to charge that merger litigation benefits only the lawyers who bring the claims, not the shareholders they represent. In response, defenders of merger litigation argue that the lawsuits serve a useful oversight function and that the improved disclosures that result are beneficial to shareholders.This Article offers a new approach to assessing the value of these claims by empirically testing the relationship between merger litigation and shareholder voting on the merger. If the supplemental disclosures produced by the settlement of merger litigation are valuable, they should affect shareholder voting behavior. Specifically, supplemental disclosures that are, in effect, "compelled" by settlement should produce new and unfavorable information about the merger and lead to a lower percentage of shares voted in favor of it. Applying this hypothesis to a hand-collected sample of 453 large public company mergers from 2005 to 2012, we find no such effect. We find no significant evidence that disclosure-only settlements affect shareholder voting.These findings warrant a reconsideration of Delaware merger law. Specifically, under current law, supplemental disclosures are viewed by courts as providing a substantial benefit to the shareholder class. In turn, this substantial benefit entitles the plaintiffs' lawyers to an award of attorneys' fees. Our evidence suggests that this legal analysis is misguided and that supplemental disclosures do not in fact constitute a substantial benefit. As a result, and in light of the substantial costs generated by public-company merger litigation, we argue that courts should reject disclosure settlements as a basis for attorneys' fee awards.Our approach responds to critiques of merger litigation as excessive and frivolous by reducing the incentive for plaintiffs' lawyers to bring weak cases, but it would have an additional benefit. Current practice drags state court judges into the task of indirectly promulgating disclosure standards in connection with the approval of fee awards. We argue, instead, for a more efficient specialization between state and federal courts in the regulation of mergers: public company merger disclosure should be policed by the federal securities laws while state corporate law focuses on substantive fairness.It is a fact evident to all of those who are familiar with shareholder litigation that surviving a motion to dismiss means, as a practical matter, that economical rational defendants . . . will settle such claims, often for a peppercorn and a fee.1-Chancellor William T. Allen in Solomon v. PatheIntroductionDeal litigation is pervasive in the United States. Multiple teams of plaintiffs file lawsuits challenging virtually every public company merger,2 often in multiple jurisdictions.3 Moreover, the frequency of merger litigation has risen sharply over the last several years.4 In 2012, 93% of deals over $100 million and 96% of deals over $500 million were challenged in shareholder litigation.5 In 2013, the frequency was even higher-97.5% of deals over $100 million were challenged through litigation, and each transaction triggered an average of seven separate lawsuits.6Although deal litigation is pervasive, these lawsuits rarely result in a monetary recovery for the plaintiff class. Rather, the vast majority end in settlement or dismissal. In most settled cases, the only relief provided to shareholders consists of supplemental disclosures in the merger proxy statement.7 In compensation for the benefit produced by these settlements-often worth no more, in the words of a famous jurist, than a "peppercorn"-plaintiffs' attorneys receive a fee award. …