Litigation is expensive and requires time, money, and resources to put together a good case. One well-recognized downside of percentage fees, such as the contingency fees used by plaintiffs’ attorneys in personal injury cases, is that they tend to cause underinvestment in litigation. In a typical percentage fee arrangement, the lawyer will bear the full costs of litigation but only get a fraction (around 20% to 30%) of the gains. This leads lawyers to invest less than if they had a greater share of the recovery.
The underinvestment problem has been empirically observed in nonlitigation contexts. For example, real estate agents typically receive a percentage of a sale; studies show that agents invest more marketing their own properties (where they get 100% of the gains) as compared to their clients’ properties. But few empirical studies have been conducted to demonstrate this common-sense result in litigation.
Expert Asymmetry: Evidence from Securities Litigation fills that gap. Co-authors Andrew Granato, Adam Callister, and Belisa Pang seek to measure the underinvestment caused by percentage fees in securities class actions, an ideal context to study underinvestment. Class attorneys receive a percentage of any recovery and front all costs. The court must approve any settlement. Databases collect settlements and relevant filings. Most importantly, the parties share one common expense – the cost of an expert to show that an alleged misrepresentation had a material effect (or not) on the stock price.
The authors develop a simple game theoretic model showing that percentage fees lead to underinvestment in plaintiffs’ experts as compared to defendants’ experts. They reviewed the dockets of settled and unsettled cases to produce a set (621 cases between 2008 and 2017) to measure any actual underinvestment. Because expert quality is difficult to observe directly, they focus on expert background, experience, and hourly wage.
The results are fascinating. Experts tend to polarize as either plaintiffs’ experts or defendants’ experts, with only a few (NERA, for example) “meaningfully” representing both sides. Defendants’ experts tended to have more “prestigious” backgrounds and academic affiliations. Most importantly, the average hourly compensation of defendants’ experts tended to be much higher than for plaintiffs’ experts. The top defendants’ expert by number of appearances charged on average $1,220.57 per hour while the top plaintiffs’ expert by number of appearances charged $1,022.53 per hour. More generally, defendants’ experts charged an average hourly rate of $1,148.61, 36.8% higher than the average hourly rate for plaintiffs’ experts of $839.36. The data suggests that the percentage fee not only leads to underinvestment for plaintiffs but creates a systematic bias in favor of the defendants in securities class actions.
The authors suggest one provocative solution to this systematic bias—more inquisitorial judging. Federal courts can appoint independent experts under Federal Rule of Evidence 706, and some have done so in complex cases, such as in litigation involving the “average wholesale price” of pharmaceuticals. I am unsure that such an approach is necessary—perhaps other methods of aligning the interests of the lawyer with the plaintiffs are available. But the suggestion is intriguing.
The article does a remarkable job of digging through the evidence to provide empirical support for a well-recognized downside of percentage fees. I am grateful for the great effort put into this project, and like it lots.
