Are Star Law Firms Also Better Law Firms?

Alberto Manconi is Associate Professor of Finance at Bocconi University. This post is based on a recent paper authored by Mr. Manconi; Allen Ferrell, Greenfield Professor of Securities Law at Harvard Law School; Ekaterina Neretina, Assistant Professor of Finance and Business Economics at the University of Southern California Marshall School of Business; Dr. William Powley; and Luc Renneboog, Professor of Finance at Tilburg University.

Since 1970, the top 10 plaintiff law firms are associated each year with around a third of all settlements in corporate litigation in the U.S. Despite the economic importance of corporate litigation as a restitution and governance mechanism, and the key role that plaintiff law firms play in its functioning, there is little systematic empirical evidence on their performance. Do “star” plaintiff law firms provide their clients with a better service and, if they do, in what ways? How competitive is the market for their services? Are there frictions that limit competition from less prestigious law firms? These questions speak to the broader issues of the effectiveness and the governance of corporate litigation.

To attempt to answer these questions, we assemble a novel, comprehensive database on plaintiff law firms in corporate litigation in the U.S. covering shareholder, intellectual property, employment, product liability, and antitrust lawsuits, as well as lawsuits related to aspects of a given industry and to government contracts and relations.

An empirical challenge to determine the value created by plaintiff law firms is distinguishing between the law firm’s “treatment” ability—i.e., the law firm makes a difference to the outcome of the lawsuit by generating a higher settlement and/or reducing the probability of a dismissal of the claim—and “selection”, in the form of assortative matching between the larger law firms and lawsuits that have an ex-ante high expected settlement amount. Separating treatment from selection is important to understand the economic mechanism driving the performance and market share of the stars. To address this challenge, we rely on corporate litigation insurance. Intuitively, if a corporation buys $100 million insurance coverage, that suggests that, in the event of litigation, it expects to be exposed to a $100 million settlement. The amount paid out by litigation insurance (henceforth, insurance coverage) is a benchmark for the expected settlement amount reflecting the selection component—star law firms are associated with lawsuits that have high expected settlement in the first place. The distance between the actual settlement and the insurance coverage estimates the treatment component—i.e., the superior performance of a star law firm.

Our results indicate that star plaintiff law firms obtain larger settlements: on average, 48% larger than other law firms. Much of that difference, however, is predicted by the litigation insurance coverage. Relative to that benchmark, the star law firms still outperform other law firms, but by a more modest, although economically non-negligible, 7%. For the average (median) lawsuit in our data, that corresponds to a $1.6 million ($200,000) larger settlement. The insurance coverage is a good benchmark of the expected settlement because (1) insurance is competitively priced; and (2) firms disclose detailed private information about potential future risks to the insurers, as failure to do so could lead to rescission action by insurance firms who can then refuse to pay the settlement for uncovered litigation risk.

The data also rule out two potential alternative explanations for the modest performance of the stars net of the insurance coverage benchmark. First, insurance coverage could absorb part of the stars’ treatment effect if the stars tend to bring lawsuits against corporations that ex ante expect a large settlement and purchase higher insurance coverage, or if defendants with lower cash holdings purchase higher insurance coverage than cash-rich ones. Comparing the lawsuits brought by stars to a matched sample having similar settlements amounts but brought by non-stars, however, delivers similar results as our baseline. Moreover, we do not observe a better performance net of the insurance benchmark for the stars against cash-rich defendants. Second, compared to other law firms, the stars could have a superior ability to obtain non-monetary benefits for the plaintiffs, such as changes in the defendant corporation’s governance. We do observe some changes in governance around the average lawsuit; but those changes are not systematically associated with the stars.

Finally, we ask how much of the stars’ performance is related to their ability to reduce the uncertainty about the outcome of the lawsuit—i.e., to reduce the chances that the lawsuit is dismissed—and what economic forces, in addition to their performance, sustain their market share. The lawsuits brought by the stars are 7-12% more likely to reach a settlement. This too can contain a selection component: for instance, plaintiffs may hire a star law firm only on more challenging lawsuits that are less likely to succeed—in this case, the 12% may underestimate the actual impact of the stars on reaching a settlement. But if the stars are retained for more challenging lawsuits, the defendants facing stars should ex ante pay lower insurance premiums, since they are less exposed to litigation—we find, however, that this is not the case.

Two pieces of evidence, on the other hand, suggest that visibility and information advantage vis-à-vis unsophisticated plaintiffs help the stars defend their market share. First, around the time a plaintiff law firm becomes a star, the size of the raw settlement amounts it obtains increases. At the same time, its performance net of the insurance coverage benchmark does not improve, consistent with the notion that visibility helps star law firms to be retained on larger, more valuable lawsuits, although their ability does not improve relative to the pre-stardom period. Second, star law firms perform better when they are retained by sophisticated plaintiffs, such as institutional investors and regulators such as the SEC, suggesting that these plaintiff categories have a better ability to select law firms to bring their lawsuits.

Our findings provide, to our knowledge, the first large-scale quantitative evidence on the performance of plaintiff law firms in corporate litigation. The literature has so far focused on the perspective of the defendant corporation, concentrating on the drivers of litigation risk, the incentive effects of the threat of litigation, or the impact of lawsuits on valuation and corporate actions. In contrast, we look at litigation outcomes from the point of view of the plaintiffs and the law firms they hire. In addition, we establish a link between the corporate finance literature on the effectiveness of corporate litigation with the law and economics literature on the principal-agent conflicts between law firms and their clients. We provide a set of novel stylized facts on the outcomes of corporate litigation: star law firms are associated with larger settlements, lower probability of a dismissal of the lawsuit, and, for a given settlement size, larger fees. This evidence can help calibrate existing models and inform further theory development.

The complete paper is available for download here.

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