Submitting Merger Lawyers to the Market Test

Matt Levine shall supply the problem:

The way merger lawsuits work is that after a deal is signed, a bunch of plaintiffs’ lawyers race to sue, claiming that the merger was underpriced, the board breached its fiduciary duties, and the whole thing was corrupt. This might sometimes be true, but it can’t be true in every merger, and the lawyers sue in virtually every merger. But then they sign a settlement with the company in which the company agrees to make a few extra disclosures about the deal and pay the lawyers a six-figure fee. The advantage for the company and the board is that the settlement binds all shareholders, so they get a release from future litigation if someone figures out that the deal was actually corrupt. The advantage for the lawyers is that they get the fee. There is no advantage for shareholders.

We shall provide the solution:

Do not pay the lawyers a cash fee.

At a random time, while the market is open, announce the disclosures that will be provided.

Then, pay the lawyers a fee proportionate to the stock’s movement (relative to the overall market) over the next hour (or second, or day, or week).

If the disclosure they heroically provided to shareholders is valuable, they will be rewarded.

But, if the disclosure they provided was a disappointment to the market, they have to pay the company. (And the court).

This system is both fair and efficient. Fair, because the lawyers will be paid if they added value to the company, and punished if they subtracted value. Efficient, because this will encourage them to only pursue lawsuits they think will add value.

Now, the lawyers (and perhaps my readers) will object that news of these disclosures would be but one small thing effecting the price of the stock that day. There would be a lot of noise – how then can it be fair to use such an unreliable method to reward the noble public servants who forced the disclosures?

And other lawyers (and perhaps other readers) will object that this could be manipulated. The lawyers could short the stock in to the announcement, and then cover their shorts when the news broke, and buy a lot of stock instead, to try to temporarily support the stock.

Fortunately, both issues can be solved together. Because this is not a single game, it is a repeated game. Any one time the lawyers might get unlucky and have the stock move “the wrong way”. But if done often enough (and this is their profession) they will come out ahead… if the disclosures they achieve are valuable. And maybe they could manipulate the stock once. But if they try to do it systematically, hedge funds will learn off it and take the opportunity to buy the stock when it is inefficiently cheap before the announcement… and then short it when the lawyers temporarily drive it up. The lawyers would need to burn a huge amount of money to manipulate the stock in the face of hedgies after an easy trade… at which point the whole thing would no longer be net profitable for them.

Does this sound plausible to you? It should, if they are adding value. If they’re on the side of angels, they should leap at the chance to have their worth measured.

Of course, this is rather a stretch. I suspect that if this were implemented, lawyers would cease these lawsuits.

And that would be good.


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