Risk aversion of class-action lawyers

The two sides in the potentially massive class-action lawsuit by silicon-valley engineers against Google, Apple, and other big tech companies reached an agreement, but that settlement was rejected by the judge. New York Times:

After the plaintiffs’ lawyers took their 25 percent cut, the settlement would have given about $4,000 to every member of the class.

Judge Koh said that she believed the case was stronger than that, and that the plaintiffs’ lawyers were taking the easy way out by settling. The evidence against the defendants was compelling, she said.

(Original court order.)

I would like to be able to explain this by understanding the economic/sociological motivations of the lawyers. People often complain about a huge chunk of the money going to the class-action lawyers who are too eager to settle, but the traditional argument is that a fixed percentage structure (rather than an hourly or flat rate) gives the lawyers the proper incentive to pursue the interests of the class by tying their compensation directly to the legal award. So this should lead to maximizing the award to the plaintiffs.

My best guess, doubtlessly considered by many others, is this: Lawyers, like most people, are risk adverse for sufficiently large amounts of money. (They would rather have $10 million for sure than a 50% chance at $50 million.) On the other hand, the legal award will be distributed over many more plaintiffs. Since it will be much smaller per person, the plaintiffs are significantly less risk adverse. So the lawyers settle even though it’s not in the best interests of the plaintiffs.

This suggests the following speculative solution for correctly aligning the incentives of the lawyers and the class action plaintiffs: Ensure that the person with the final decision-making power for the plaintiff legal team receives a percentage of the award that is small enough for that person’s utility function to be roughly as linear as the plaintiffs’. This could mean (a) spreading the legal work over many lawyers such that the potential compensation for each is smaller, (b) compensating the lead lawyer less than his colleagues, or (c) turn the class-action lawsuit legal team into a corporation with a director that must answer to many shareholders.

Proposal (a) has problems because it might require the number of lawyers to be comparable to the number of plaintiffs, which could be thousands or millions. Proposal (b) is awkward for the lawyer pecking order, and could lead to bad lead lawyers or the lead lawyer being pressured by his colleagues to settle. Proposal (c) strikes many people as weird, and introduces other principal-agent problems, but it does have precedence.

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3 Comments

  1. Risk aversion is no doubt a part of the problem, but remember that class-action firms have (generally speaking) fixed costs for pursuing a case. They have to cover the salaries of associates, paralegals, legal secretaries, etc. working on the case as well as a share of their firms overhead. These costs are “fixed” in the sense that they don’t increase or decrease much in relation to the size of potential damages. These fixed costs exacerbate the misalignment of incentives created by the lawyers greater risk aversion (itself a consequence of the lawyers being smaller in number than the class), since the lawyers will have a strong incentive to settle so long as they cover these costs, even if the settlement is a tiny fraction of potential damages. So, to better align the incentives of class-action lawyers with those of the plaintiffs you could:

    *Provide public financing for “support costs” for cases that achieve class certification.
    *Create a mandatory public insurance pool that covers support costs for class actions that achieve certification but lose at trial, with premiums paid out of settlements and awards.
    *A graduated fee structure, so that the lawyers get a higher % of the award if they recover a higher % of claimed damages.

    Only the last one seems realistic to me, but it could easily have its own undesirable unintended consequences.

  2. There’s also the cost of litigation, the opportunity cost of not doing something else, and the present value of an uncertain payment at an uncertain future date. Given the likelihood of appeals (which could take a decade), it seems plausible that plaintiffs legal team decided that settling now maximizes their rate of return.

    While Judge Koh makes the point that plaintiffs received class certification after the settlement was agreed to, strengthening their position, I don’t think it’s a coincidence that the settlement was arrived at just a few months after SCOTUS decided Comcast v. Behrend. Along with Wal-Mart v. Dukes (decided after the initial filings in this case), recent SCOTUS decisions have made class certification quite a bit more difficult. Plaintiffs legal may also be discounting support from the Ninth Circuit, since Wal-Mart overturned a Ninth Circuit decision.

    So, it’s complicated.

    • > There’s also the cost of litigation, the opportunity cost of not doing something else, and the present value of an uncertain payment at an uncertain future date.

      OK, but all of these exist for any suit. The interesting question to me is how incentives get misaligned for class action in particular.

      > Judge Koh makes the point that plaintiffs received class certification after the settlement was agreed to, strengthening their position

      I hadn’t realized this, thanks.

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