Japan's love for derivative actions: irrational behavior and non-economic motives as rational explanations for shareholder litigation.

• Author: Puchniak, Dan W.

ABSTRACT

Not long ago, there was a consensus in the legal academy that the Japanese were irrational litigants. As the theory went, Japanese people would forgo litigating for financial gain because of a cultural obsession with maintaining social harmony. Based on this theory, it made perfect (but economically irrational) sense that Japanese shareholders let their U.S.-transplanted derivative action lay moribund for almost four post-war decades, while at the same time the derivative action was a staple of shareholder litigation in the United States.

The 1980s brought a wave of law and economics to the scholarship of Japanese law, which largely discredited the cultural explanation for Japan's (economically irrational) reluctant litigant. In this new academic era, reasonable minds could disagree as to whether the efficiency of settlement or high cost of litigation explained the dearth of litigation in Japan. However, the assumption that the Japanese litigant was economically motivated and rational (i.e., that they would litigate only when the financial benefit from doing so exceeded the cost) was virtually beyond reproach.

In the early 1990s, the number of derivative actions in Japan skyrocketed. Japanese shareholders suddenly found themselves as strange bedfellows with their American counterparts as the only shareholders of listed companies in the world that utilized the derivative action on a regular basis. This extraordinary change in the behavior of Japanese shareholders has largely been understood through the lens of the economically motivated and rational shareholder litigant.

This Article challenges the assumption that the dramatic increase in Japanese derivative actions can be understood solely through the narrow lens of the economically motivated and rational shareholder. Using original empirical and case study evidence, this Article demonstrates that in Japan, neither shareholders nor attorneys stand to gain significant financial benefits from derivative actions. To the contrary, this Article suggests that the non-economic motives (i.e., political and environmental motives and veiled extortion) and irrational behavior of Japanese shareholders, (i.e., the use of inaccurate mental heuristics, self-serving bias, and herding behavior) are critical for providing an accurate explanation for one of the most dramatic increases in shareholder litigation in recent times. This revelation further suggests that the leading literature on shareholder litigation--which forms the basis for the current understanding of shareholder litigation in the United States--is flawed, as it overlooks the critically important role that non-economic motives and irrational behavior play in driving shareholder lawsuits.

TABLE OF CONTENTS I. INTRODUCTION II. THE FLAWED ASSUMPTION OF THE ECONOMICALLY MOTIVATED AND RATIONAL SHAREHOLDER LITIGANT AND ITS APPLICATION TO DERIVATIVE ACTIONS A. The Theory of the Economically Motivated and Rational Shareholder Litigant Is Fundamentally Flawed B. The Theory of the Economically Motivated and Rational Litigant Is the Foundation of Derivative Actions Scholarship III. APPLYING THE ASSUMPTION OF THE ECONOMICALLY MOTIVATED AND RATIONAL SHAREHOLDER LITIGANT TO JAPAN A. The Rational Explanation for the Absence of Shareholder Litigation in Post-War Japan B. Japan's Explosion of Derivative Actions: (Mis)Understood Through the Lens of the Economically Motivated and Rational Shareholder Litigant and Its Testable Hypotheses IV. PUTTING THE HYPOTHESES OF THE ECONOMICALLY MOTIVATED AND RATIONAL JAPANESE DERIVATIVE LITIGANT TO THE TEST A. Testing the Economically Motivated and Rational Shareholder Hypothesis: Do Shareholders Financially Benefit from Derivative Actions in Japan? B. Testing the Economically Motivated and Rational Attorney Hypothesis: Do Economically Motivated and Rational Attorneys Drive Derivative Litigation in Japan? C. Testing the Financial Tracking Hypothesis: Does the Rate of Derivative Actions Track Changes in Their Financial Costs and Benefits? V. PROVIDING A RATIONAL EXPLANATION FOR NON-ECONOMICALLY MOTIVATED AND IRRATIONAL DERIVATIVE LITIGATION IN JAPAN A. Demarcating the Boundaries Between Rational and Irrational Behavior B. Quasi-Rational Behavior Drives Derivative Litigation in Japan C. Purely Irrational Behavior as a Potential Driver of Derivative Litigation in Japan VI. VALUABLE LESSONS FROM AN UNDERSTANDING OF NON-ECONOMICALLY MOTIVATED AND IRRATIONAL SHAREHOLDER LITIGANTS I. INTRODUCTION

Not long ago, there was a consensus in the legal academy that the Japanese were irrational litigants. As the theory went, Japanese people would forgo litigating for financial gain because of a cultural obsession with maintaining social harmony. (1) Based on this theory, it made perfect (but economically irrational) sense that Japanese shareholders let their U.S.-transplanted derivative action lay moribund for almost four post-war decades while at the same time the derivative action was a staple of shareholder litigation in the United States. (2)

The 1980s brought a wave of law and economics to the scholarship of Japanese law, which largely discredited the cultural explanation for Japan's (economically irrational) reluctant litigant. In this new academic era, reasonable minds could disagree as to whether the efficiency of settlement or high cost of litigation explained the dearth of litigation in Japan. However, the assumption that the Japanese litigant was economically motivated and rational (i.e., as classical economic rational choice theory predicts that they would litigate only when the financial benefit from doing so exceeded the cost) was virtually beyond reproach. (3)

In the early 1990s, the number of derivative actions in Japan skyrocketed. (4) Japanese shareholders suddenly found themselves as strange bedfellows with their American counterparts as the only shareholders of listed companies in the world that utilized the derivative action on a regular basis. (5) This extraordinary change in the behavior of Japanese shareholders is largely understood through the narrow lens of the economically motivated and rational shareholder litigant. Specifically, a consensus has emerged that the number of derivative actions has dramatically increased in Japan because the exorbitant fee for filing a derivative action was largely eliminated in 1993. (6) As the theory goes, since 1993, economically motivated and rational Japanese shareholders have utilized derivative actions because the financial benefit of doing so has exceeded the cost.

This Article challenges the assumption that the dramatic increase in Japanese derivative actions can be understood solely through the narrow lens of the economically motivated and rational shareholder. Using original empirical and case study evidence, this Article demonstrates that the norm in Japan is that neither shareholders nor attorneys stand to gain significant direct financial benefits from pursuing derivative actions. To the contrary, our empirical evidence suggests that in most cases it is economically irrational for shareholders and attorneys to pursue derivative actions in Japan (i.e., the risk adjusted ex ante financial cost of pursing a derivative action normally outweighs the direct financial benefit). This finding gives rise to a conundrum: if it is normally economically irrational to pursue derivative actions in Japan, how has Japan become a world leader in derivative litigation?

This Article attempts to solve this conundrum by expanding the narrow lens of classical economic rationality to consider the possibility that non-economic motives and irrational behavior may provide valuable insights into the dramatic increase in derivative litigation in Japan. Our case study, empirical, and econometric analyses demonstrate that social activists seeking political (non-economic) benefits are the single largest force driving derivative litigation in Japan. In addition, the sokaiya, (7) which often have strong ties to the yakuza (Japanese mafia), have pursued a significant number of derivative actions in Japan. We suggest that the sokaiya are willing to engage in prima facie economically irrational derivative actions because such litigation enhances their reputation for extortion, which ultimately provides them with indirect economic gains. These findings are important because most of the leading literature on shareholder litigation erroneously assumes that shareholders rationally decide to sue based solely on a narrow ex ante analysis of the direct financial cost and benefit of bringing a shareholder action.

We note that based on a wider definition of "rationality"--which assumes that rational behavior is any behavior that increases an actor's overall level of well-being--the reputational, indirect-economic, and politically motivated derivative actions engaged in by social activists and sokaiya would be seen as "rational." Behavioral law and economics scholars normally rely on this wider, utility-maximizing, definition of rationality which to date has received scant attention in the shareholder litigation literature. This Article demonstrates that the failure to integrate this wider view of rationality into the shareholder litigation literature has led to a myopic understanding of why shareholders sue because it neglects to account for non-economic motives and thus fails to accurately explain a significant portion of shareholder litigation in Japan (and, we suspect, everywhere else).

Perhaps more interestingly, even based on a wider "utility-maximizing" definition of rationality, a substantial portion of Japan's derivative litigation remains inexplicable in that it appears to be driven by purely irrational behavior. Putting aside social activist and sokaiya driven litigation, the remaining universe of derivative litigation in Japan appears to be driven by shareholders and attorneys engaging in "utility-decreasing" behavior that is against their own...