The Effect of Statutory Indemnity on Securities Class Action Litigation Settlements: A First Look

The study analyzes the effect of statutory indemnity on securities class action settlement amounts. This is the first study that we are aware of to focus specifically on the association between directors' and officers' indemnification and securities class action settlement amounts. Corporate charter provisions offering indemnity to directors and officers shift costs related to insurance rescission and to residual settlement amounts from directors' personal assets to the balance sheet of the firm. We find evidence that, for a given amount of damages claimed by plaintiffs, the shift in risk away from director/officer personal assets results in higher settlement amounts. We posit that this may result from the adverse impact of statutory indemnity on management's incentives to exercise due care in accounting decisions and public disclosures. We also find a countervailing effect of indemnity. Our results suggest that statutory indemnity decreases the amount of damages claimed by the plaintiffs. Such decrease could be a result of stricter selection and retention of managers who exercise appropriate care in public disclosures and accounting decisions. We conjecture that firms offering statutory indemnity respond to the moral hazard of offering indemnity to directors and officers by implementing stricter selection policies. Although the total effect of statutory indemnity on the settlement amount appears to be small and statistically insignificant, the additional costs incurred in stricter selection and screening would still be borne by all shareholders. [PUBLICATION ABSTRACT]