The Private Ordering Solution to Multiforum Shareholder Litigation

• Author: Sarath Sanga,Roberta Romano
• DOI: http://doi.org/10.1111/jels.12141
• Date: 01 March 2017
• Published date: 01 March 2017

The Private Ordering Solution to

Multiforum Shareholder Litigation

Roberta Romano* and Sarath Sanga*

This article analyzes a private ordering solution to multiforum shareholder litigation:

exclusive forum provisions in corporate charters and bylaws. These provisions require

that all corporate-law-related disputes be brought in a single forum, typically a court in

the statutory domicile. Using hand-collected data on the 746 U.S. public corporations

that have adopted the provision, we examine what drives the growth in these provisions

and whether, as some critics contend, their adoption reflects managerial opportunism.

We find that nearly all new Delaware corporations adopt the provision at the IPO stage,

and that the transition from zero to near-universal IPO adoption over 2007--2014 is

driven by law firms. Characteristics of individual companies appear to play little or no

role in adoption decisions. Instead, the pattern of adoption follows what can be

described as a light-switch model, in which law firms suddenly switch from never

adopting to always adopting the provision in the IPOs they advise. For post-IPO (or

“midstream”) adoptions, we compare corporate governance features of adopters to a

matched sample of nonadopters to test the hypothesis that midstream bylaw adoption

reflects managerial opportunism. If the hypothesis were correct, then we would expect

to find that the midstream adopters exhibit poor corporate governance compared to

nonadopters (using the metrics of good governance practices as identified by critics of

the provisions). We find, however, that there are either no significant differences in

governance or that it is adopters that have higher-quality governance features. We also

find no significant differences in governance and ownership structures between firms

whose boards adopt the provisions as bylaws and those who obtain shareholder

approval. The absence of significant differences across firms using disparate adoption

procedures suggests that the method of adopting an exclusive forum provision---

whether wit h or without sh areholde r approval---sh ould not be a mat ter of impor t for

investors.

*Address correspondence to Roberta Romano, Yale Law School, P.O. Box 208215, New Haven, CT 06520-8215;

email: roberta.romano@yale.edu. Romano is Sterling Professor of Law, Yale Law School, and at the National

Bureau for Economic Research; Sanga is Assistant Professor, Northwestern University, Pritzker School of Law.

We have benefited from comments from participants at workshops at Boston University School of Law, Hum-

boldt University Berlin, New York University School of Law, University of Bonn, University of Tokyo, Yale Law

School, and at the 2015 Washington University School of Law, St. Louis Conference on Empirical Legal Studies,

University of Pennsylvania Institute of Law and Economics Corporate Roundtable, and 20th Annual Conference

of the Society of Institutional and Organization Economics. We thank the Legal 500 Series for generously provid-

ing us access to their archived law firm ratings for use in our analysis.

31

Journal of Empirical Legal Studies

Volume 14, Issue 1, 31–78, March 2017

I. Introduction

Shareholder suits against Delaware corporations have been increasingly filed in multiple

forums.

1

This trend would appear to be puzzling because it is at odds with the widely

held view that the expertise of Delaware courts actually benefits shareholders.

2

The

trend is less puzzling, however, if one appreciates that while this may be true on average,

it may not be true for every individual shareholder. Further, it is shareholders’ attorneys

who decide in which forum to file a lawsuit, but, as has been long-recognized in the lit-

erature, attorneys’ incentives may be misaligned with the interests of their clients.

3

Commentators have proposed a number of responses to multiforum litigation,

including judicial, legislative, and private ordering solutions.

4

This article focuses on

one private ordering solution: exclusive forum provisions. An exclusive forum provision

in a corporation’s charter or bylaws is analogous to a forum selection clause in a con-

tract. It identifies a single forum, most typically a court in the corporation’s statutory

domicile, as the venue for corporate-law-related disputes. The number of firms adopting

this self-help solution has dramatically increased in recent years, following its endorse-

ment by the Delaware Chancery Court and a number of other state courts.

There has been limited investigation of which firms adopt exclusive forum provi-

sions. But a better understanding of which firms adopt exclusive forum provisions would

shed light on whether shareholders should be concerned about their own firms

1

E.g., John Armour et al., Is Delaware Losing its Cases? 9 J. Emp. Leg. Stud. 605 (2012) [hereinafter Armour

et al., Losing]; Jennifer J. Johnson, Securities Actions in State Court, 80 U. Cin. L. Rev. 349 (2012); Edward B.

Micheletti & Jenness E. Parker, Multi-Jurisdictional Litigation: Who Caused This Problem and Can it Be Fixed?

37 Del. J. Corp. L. 1 (2012).

2

E.g., RobertaRomano, Law as a Product:Some Pieces of the IncorporationPuzzle, 1 J. L. Econ.& Org. (1985);Leo E.

Strine,Jr., The Delaware Way: How We Do CorporateLaw and Some of the New Challenges We (and Europe)Face, 30

Del.J. Corp. L. 673, 682--83(2005); E. Norman Veasey,An Economic Rationalefor JudicialDecisionmakingin Corporate

Law,53 Bus. Law. 681, 683,694 (1998). SarathSanga, Choice of Law:An Empirical Analysis,11 Journal of EmpiricalLegal

Studies894 (2014) (showingthat Delawareis also the most over-representedchoiceof law in commercial contracts).

3

E.g., John C. Coffee, The Unfaithful Champion: The Plaintiff as Monitor in Shareholder Litigation, 58 Law &

Contemp. Prob. 5 (1985). As Thompson and Thomas describe multijurisdictional corporate litigation, it is “fee

distribution litigation,” that is, the function of an out-of-state forum filing is to obtain for the attorney a share of

a fee award, and not to contribute to the resolution of a dispute. Randall S. Thomas & Robert B. Thompson, A

Theory of Representative Shareholder Suits and its Application to Multijurisdictional Litigation, 106 Nw Univ. L.

Rev. 1753, 1801 (2012). This dynamic is possible because a settlement in one forum can release the defendant

from liability for all claims related to the disputed transaction asserted by any other shareholder in any other

forum. See Matshushita Elec. Indus. Co. v. Epstein, 516 U.S. 367 (1996); Minor Myers, Fixing Multi-Forum Share-

holder Litigation, 2014 Univ. Ill. L. Rev. 467, 496--97.

4

These solutions are discussed in Section II. Not all commentators consider this phenomenon problematic. For

articles endorsing multijurisdictional litigation, see Sean J. Griffith & Alexandra D. Lahav, The Market for Preclu-

sion in Merger Litigation, 66 Vand. L. Rev. 1053 (2013); Faith Stevelman, Regulatory Competition, Choice of

Forum, and Delaware’s Stake in Corporate Law, 34 Del. J. Corp. L. 57 (2009); for articles viewing it as problemat-

ic, see John Armour et al., Delaware’s Balancing Act, 87 Ind. L.J. 1345 (2012); Benjamin D. Landry, Mutual

Assent in the Corporate Contract: Forum Selection Bylaws, 18 Fordham J. Corp. & Fin. L. 1 (2013); Micheletti &

Parker, supra note 1; Myers, supra note 3; Leo E. Strine, Jr., et al., Putting Stockholders First, Not the First-Filed

Complaint, 69 Bus. Law. 1 (2013--2014).

32 Romano and Sanga

adopting (or not adopting) the provision. It would also shed light on whether this pri-

vate ordering solution obviates the need for judicial or legislative intervention. Using

hand-collected data on all 746 U.S. public corporations that have adopted the provision

(as of August 2014),

5

we analyze the extent to which adoption is associated with a firm’s

internal governance structure versus its external influences (such as outside counsel).

Throughout the analysis, we draw a distinction between firms that have the provi-

sion at the time of their IPO (IPO adopters) and those that have adopted a provision

after their IPO (midstream adopters). The dynamics of adoption at these two stages dif-

fer considerably. When adoption occurs before the IPO, any potential wealth effect can

be impounded into the stock price before public investors purchase their shares. In con-

trast, when adoption occurs after the IPO, public shareholders have no such opportuni-

ty to price-in the potential wealth effect. If the value of the provision were negative,

then midstream adoption could generate a loss for shareholders. Thus, in contrast to

provisions in place at the IPO, post-IPO amendments to corporate documents (often

referred to as “latecomer terms”)

6

could transfer wealth from shareholders to manage-

ment (or vice versa). For this reason, we use different empirical strategies to analyze

IPO and midstream adoption.

Our analysis of IPO adoption yields two principal results. First, adoption is

approaching universality as from January 2010 to August 2014, the rate of adoption of

Delaware IPOs has risen steadily from 0 to 80 percent. Second, company-specific charac-

teristics, such as industry or firm size, play little to no role in the adoption decision.

Instead, we find that the most significant predictor of IPO adoption is having outside

counsel who has previously advised an IPO adopter. That is, the data fit a model in

which law firms abruptly switch from never adopting to always adopting the provision.

Although we identify a similar adoption pattern for investment banks underwriting the

issues, when their role is analyzed jointly with law firms, only the law firm light-switch

effect remains. These results are consistent with the characterization that law firms

make a once-and-for-all decision to unconditionally advise their corporate clients to

adopt an exclusive forum provision before going public.

Our analysis of midstream adoption yields two related results. First, there are mini-

mal to no differences in corporate governance between adopters and nonadopters. Fur-

ther, when there is a significant difference, it is adopters that have “better” governance

5

The first exclusive forum bylaw in our sample was adopted by Oracle Corp. in 2006. The first exclusive forum

charter provision included in the certificate of a company on going public (IPO firm) was adopted by Netsuite

Inc. in 2007. Three corporations adopted exclusive forum provisions in the 1990s that went large ly unheralded,

and so, as Joseph Grundfest puts it, they were “evolutionary deadends,” and, in fact, two of those companies

removed the clauses in the past decade. Joseph A. Grundfest, The History and Evolution of Intra-Corporate

Forum Selection Clauses: An Empirical Analysis, 37 Del. J. Corp. L. 333, 352 (2012). Grundfest further describes

the evolution of the language of the clauses, which followed two templates distinguished by whether the board

can waive a clause’s application; the elective version---which is the type of provision that he drafted for Netsuite---

has quickly come to predominate over the nonwaivable form of the earliest provisions drafted in the 1990s. Id.

6

The phrase was coined by Frank Easterbrook and Daniel Fischel to emphasize the differential wealth effect of

midstream charter changes from terms in place at the initiation of an investment. Frank H. Easterbrook & Daniel

R. Fischel, The Corporate Contract, 89 Colum. L. Rev. 1416, 1442--43 (1989).

33The Private Ordering Solution to Multiforum Shareholder Litigation