The Economic Costs of Frivolous Securities Litigation
Jun 14, 1999

Frivolous securities litigation has become a thriving business - a way of extracting money from high-technology and entrepreneurial firms. But in addition to harming individual companies, these "strike suits" threaten the U.S. economy.

The primary goal of securities litigation is to protect the public interest by assuring the integrity of capital markets. Most empirical evidence to date suggests that current legal practice is: 1. inefficient, because the uncertainty in estimating potential damage awards impedes efficient settlement; and 2. ineffective, because the size of damage awards is not correlated to the social costs of violation.

Litigation has become an unintended and ineffective substitute for market-appropriate regulation and corporate governance by active shareholders. Associated agency costs have risen without concomitant returns to shareholders or improvement in corporate performance and maximization of shareholder value.

The overwhelming conclusion that emerges is that these strike suits have created an additional tax upon technology-based businesses and entrepreneurial finance in the nation's growth sectors, resulting in rent-seeking behavior by litigation agents at the cost of profit maximization at the firm level.

The purpose of this policy short is to provide a brief research review of the existing empirical knowledge base about the economic consequences of frivolous securities litigation.