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IMPROVING CORPORATE GOVERNANCE THROUGH LITIGATIONS:

DERIVATIVE SUITS AND CLASS ACTIONS IN KOREA

OK-RIAL SONG Assistant Professor, Seoul National University

osong@snu.ac.kr / 82-2-880-1449

INTRODUCTION

Among many corporate monitoring tools, corporate litigations—class actions and derivative suits—have a distinctive feature: a relatively feasible ex post remedy for serious governance failure. Since they are likely to deprive managers of money, prestige, or even their jobs, these suits serve an important threatening or disciplinary function that can deter the management from engaging in wrongdoings. Moreover, such deterrence effect may well be emphasized once the limited role of the current monitoring measures is taken into account. Several recent researches using the U.S. data found that the ex ante corporate governance devices might not be more efficient than expected. Outside or independent directors, for instance, have little to do with firm performance; executive compensation scheme not only fails to reduce agency costs but rather results from or magnify such costs; and institutional investors lacks sufficient incentive to monitor. The market for corporate control, which the commentators tend to prefer, seems to disappear even in the U.S. market. In this situation, corporate litigations might be the last resort for efficient corporate governance system, and this essay explores why and how to establish them in Korea.

During the past decade since the East Asian financial crisis, Korea also

struggled to establish the transparent and accountable corporate governance system. Since then, as widely noted, the corporate law and securities regulation had experienced a rapid change primarily by adopting Anglo-American-styled legal framework for corporate governance issues. As a result, the Korean corporate law and securities regulation are generally referred to provide next to world-class investor protection.1 To name a few, shareholder proposal, voting by mail, cumulative voting, stock option, and audit committee had been stipulated in the statute. Appointment of several outside or independent directors was mandated for listed companies, and large firms should have more than 50% of the

* Assistant Professor, Seoul National University College of Law. 1 See Hwa-Jin Kim, Living with the IMF: A New Approach to Corporate Governance

and Regulation of Financial Institutions in Korea, 17 BERKELEY J. INT’L. L. 61, 70-81 (1999) (describing the recent changes in Korean Securities and Exchange Act and Korean Commercial Code); Ok-Rial Song, The Legacy of Controlling Minority Structure: A Kaleidoscope of Corporate Governance Reform in Korean Chaebol, 34 L. & POL. INT’L. BUS. 183, 220-226 (2002) (calculating the LLSV index for post-crisis Korea).

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all directors be independent. Minimum shareholding requirements for exercising certain shareholders’ rights were dramatically diminished. As far as the statutory level of regulation is concerned, therefore, it can be fairly said that the Korean legal frameworks are now at least not much different to those of the U.S. or western developed countries.

As we can see in the recent corporate scandals in which several major

business groups (chaebols) are involved, however, the actual practice of Korean chaebols seems to persist despite the recent statutory reforms. Still, the shameful description that professor Shleifer and Vishny made before the above institutional reforms for the Korean corporate governance, and for the chaebol system in particular, still holds to some extent.2 Several observations may provide a clue. Outside directors, for instance, are likely to be chosen by managers or controlling shareholders, who are deemed to be monitored. Stock option is just regards as a windfall, because the informational efficiency of the Korean stock market has not yet firmly established and thus firm value is hardly reflected to its stock price. Even the market for corporate control is not working in Korea.

Worst of all, the class actions and derivative suits do not help, simply

because almost no such suit has been filed. To my best knowledge, fewer than 10 derivative suits have been filed since the late-1990s, and the class action has never been filed since its adoption in 2005. The derivative lawsuits were not initiated by shareholders or entrepreneurial lawyers, but rather they were filed by an NGO called “People’s Solidarity for Participatory Democracy (PSPD).”3 Chances are, however, such derivative suits may be poorly tuned up from the efficiency point of view, because they are filed not for the pecuniary reason, but rather with a mission to cure Korean corporate governance system. Due to lack of financial and human resources, the PSPD was only able to bring a few lawsuits against the limited number of large corporate groups like Samsung or Hyundai. Thus, although the derivative lawsuits that the PSPD filed attracted much attention, little threatening function was achieved. At least as of now, when managers and controlling shareholders violated their fiduciary duties or committed securities crimes, they were more likely to be criminally prosecuted as we saw in the recent corporate scandals, rather than to be privately sued by investors.

Against this backdrop, this essay, employing the comparative approaches,

examines why class actions and derivative suits have been rarely used in Korea despite the statutory similarities to those of the U.S. and Japan, and argues that, in order to activate such litigations, it is necessary to provide more pecuniary

2 “Korean chaebol sometimes sell their subsidiaries to the relatives of the chaebol

founder at low prices. . . . In many countries today, the law protects investors better than it does in Russia, Korea, or Italy.” See Andrei Shleifer & Robert W. Vishny, A Survey of Corporate Governance, 52 J. FIN. 737, 742 (1997).

3 See generally Boong-Kyu Lee, Don Quixote or Robin Hood? Minority Shareholder Rights and Corporate Governance in Korea, 15 COLUM. J. ASIAN L. 345, 353-356 (2002).

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incentives for plaintiff lawyers. That is to say, this essay asserts that the emergence of lawyer-driven litigation market, which is quite similar to the U.S. model, is more desirable in improving the Korean corporate governance system.

To say that the corporate litigations should be more activated, however,

there are several caveats we should be fully aware of. Contrary to the conventional understanding, the empirical tests show that class actions and derivative suits are very unlikely to result in the increase of shareholder value in terms of the stock price gain.4 Even the recent study using the Japanese derivative litigation data reports no significant shareholder gain associated with filing a derivative suit.5 Assuming these results are true, why should we believe that it is a good idea to encourage investors to sue? My comment on this question is that the social gain, which should be distinguished to the stock price gain of specific shareholders of defendant company, may be already incorporated in the stock price of each company in that jurisdiction, and thus bringing a lawsuit might not be associated with any abnormal returns. The social gain comes from the disciplinary or threatening nature of the suits, and thus mere possibility, not actual bringing, of lawsuits accounts for the gain. Therefore, the magnitude of such gain depends on the extent to which the shareholders or investors—in a specific jurisdiction—are likely to bring lawsuits if managerial wrongdoings are revealed. Put differently, the actual filing a suit is not an event, or at best tells anything other than social benefit associated the disciplinary effect of corporate litigations.

The other concern is the collusive settlement between defendant managers

and plaintiff attorneys, as witnessed in the U.S. class actions and derivative suits. As widely noted, such practice enables the U.S. plaintiff lawyers to file frivolous suits. The efficiency concern of the collusive settlement and frivolous suit is that, if the disputes are likely to end up with settlement, which does not depend on the merit of the suits, any threat or deterrence may not be generated. Then, why should we think that the concept of “lawyer-driven” litigation system is still convincing? This essay suggests several possibilities. First, the culture might be different from country to country, and thus such practice might be controlled by invisible hand. Second, the law might explicitly establish several barriers to this practice. The PSLRA of 1995 in the U.S. may be the most notable example, and the Securities Class Action Act in Korea also stipulated the same provisions. Third, several procedural rules in civil lawsuits might prevent frivolous suits from being filed. Finally, if the problem is aggravated, legislators or judiciary may enact special rules designed to cut off the monetary profits of plaintiff lawyers from settlement. Therefore, we don’t have to be concerned about the “abuse” of

4 See Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the

Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 CORNELL L. REV. 261 (1986); Roberta Romano, The Shareholder Suit: Litigation Without Foundation? 7 J.L. ECON. & ORG. 55 (1991).

5 See CURTIS J. MILHAUPT & MARK D. WEST, ECONOMIC ORGANIZATIONS AND CORPORATE GOVERNANCE IN JAPAN 23-28 (2004).

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corporate litigations for a while. In fact, it should be emphasized that excessive attention to the abusive practices may involve some risk of paralyzing the corporate litigation system itself. As we can see below, the Korean Securities Class Action Act is the exact example of this mistake.

Although this essay focused on derivative suits and class actions, the role

of corporate litigations with regard to improving the corporate governance should not be too exaggerated. The negative feature of lawsuits—as an ex post liability measure—in comparison with the market for corporate control is that they apply for the limited and manifest violation of fiduciary duties. In other words, shareholders are not able to sue the managers who lack management skills but are loyal to them, while the market for corporate control is capable of punishing such inefficient managers. Therefore, relying on the corporate litigations certainly help to prevent managers from betraying shareholders, but may fail to achieve the economic efficiency. That is why the corporate litigations should never be regarded as a substitute for other monitoring devices.

This essay consists as follows. Part I discusses preliminarily on the

theoretical importance of corporate litigations—class actions and derivative suits—in corporate governance practice. Part II is devoted to describe the Korean derivative suits and class actions from the comparative perspectives. Comparison of the derivative suits between the United States, Japan, and Korea shows that the statutory differences between three countries are quite minimal and thus not sufficient to explain the reality. In fact, it seems to be easier for shareholders in Korea to file a lawsuit than in United States. Similarly, comparison of the class actions between the United States and Korea reveals that the differences, if any, are still negligible. Nevertheless, the overall shape of the corporate litigations is totally different. Part III addresses several questions such as the sources of such ineffective corporate litigations, the assessment and plausible reform proposals of current system, and several solutions for the abusive practices.

I. THEORETICAL IMPORTANCE OF CORPORATE LITIGATIONS

1. Ex Ante Regulation vs. Ex Post Liability

To prevent managers from engaging in misbehaviors, investors may hire outside directors or auditors (ex ante regulation) or, instead, file the suits against disloyal managers (ex post liability). Several researches have explored the optimal mix of ex ante regulation and ex post liability in various contexts,6 and the results can be applied to the corporate governance system.

6 See, e.g., Charles D. Kolstad, Thomas S. Ulen & Gary V. Johnson, Ex Post Liability for Harm vs. Ex Ante Safety Regulation: Substitute or Complements? 80 AM. ECON. REV. 888 (1990); Steven Shavell, Specific versus General Enforcement of Law, 99 J. POL. ECON. 1088 (1991); Dilip Mookherjee & I.P.L. Png, Monitoring vis-à-vis Investigation in Enforcement of Law, 82 AM. ECON. REV. 556 (1992).

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One well-known type of extreme analysis contended that the ex post liability scheme is superior, since the damages merely transfer wealth, without imposing any social cost. On the contrary, ex ante monitoring mechanisms are costly, and moreover, such costs are imposed even if managers’ non-compliance is unlikely. Needless to say, for instance, the mandatory disclosure regime needs a lot of human and financial resources to maintain the system. Outside directors are also costly, because they spend their time in relatively less specialized areas. Since it is quite hard to find a competent and efficient person who has plenty of time at the same time, the person who is really “independent” is likely to inept. In this case, therefore, the decision made by outside directors may result in some inefficiency on the firm level. Ex post liability regimes such as class actions, derivative suits, and hostile bids are costless in that they are triggered only when someone finds corporate mismanagement; as long as managers do not engage in wrongdoing, they impose no cost on the firm.7

As a matter of fact, however, such superiority might be illusive. If the

class actions or derivative suits are to properly function, there must be enough number of such events, and therefore they also entail several administrative costs. Additional social costs will be incurred if the suits are brought excessively. Arguably, therefore, it is wrong to assert that the class actions and derivative suits are relatively cheaper than ex ante tools. It might be rather safe to say that the trade-off between these two ex ante and ex post mechanisms depends on their relative costs for achieving the same level of managerial effort.8 In that sense, it may be strongly argued that the corporate litigations are more valuable, if the other monitoring mechanisms are not well-functioning.

In fact, it is the case for Korea. Since the East Asian financial crisis, the

Korean corporate law and securities regulations had experienced a rapid change to establish the transparent and accountable corporate governance system. As examined below, however, several implantations from the developed countries are sometimes turned out to be unsuccessful in Korea. 2. Ineffective Monitoring System

Since the late-1990s, there have been rigorous researches on correlation or causation between corporate governance and firm performance. Among them, several studies have tried to show how effectively or efficiently the specific ex

7 Cf. FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF

CORPORATE LAW, 280-285 (1991) (arguing that an anti-fraud rule is costless compared to the market signaling devices, because an anti-fraud rule “imposes low or no costs on the honest, high-quality firm”).

8 See Mookherjee & Png, supra note 6, at 557 (arguing that, “if the direct cost of [ex post liability] is sufficiently low and the offense is adequately reported at all levels,” only ex post liability scheme should be adopted).

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ante corporate governance devices are working. Unfortunately, however, the results were negative, or mixed at best.

Outside or independent directors, for instance, have little to do with firm

performance.9 Current practice of independent directors shows how difficult it is to make the board “at the same time knowledgeable about the company and independent from management.”10 Executive compensation is also under suspicion. In fact, the sensitivity of executive compensation to stock price is hardly established even in the U.S. stock market.11 Moreover, recent research on executive compensation argues that the compensation scheme not only fails to

9 See Ronald J. Gilson & Reinier Kraakman, Reinventing the Outside Director: An

Agenda for Institutional Investors, 43 STAN. L. REV. 863, 874-875 (1991) (“Good character and financial independence from management may be necessary conditions for effective monitoring [of independent board], but they are hardly sufficient.”); Laura Lin, The Effectiveness of Outside Directors as a Corporate Governance Mechanism: Theories and Evidence, 90 NW. U.L. REV. 898, 921-939 (1996) (summarizing mixed empirical evidence on the net effect of outside directors); Jill E. Fisch, Corporate Governance: Taking Boards Seriously, 19 CARDOZO L. REV. 265, 276-278 (1997) (same); Ira M. Millstein & Paul W. MacAvoy, The Active Board of Directors and Performance of the Large Public Traded Corporation, 98 COLUM. L. REV. 1283, 1310-1317 (1998) (showing a statistically significant relationship between an active, independent board and superior corporate performance) (emphasis added); April Klein, Firm Performance and Board Committee Structure, 41 J.L. & ECON. 275, 287-296 (1998) (finding that, while there is no positive relation firm performance and board composition, insider directors can be more valuable board members, if properly used, than outside directors); Sanjai Bhagat & Bernard Black, The Uncertain Relationship between Board Composition and Firm Performance, 54 BUS. LAW. 921, 940-950 (1999) (showing that the boards with a majority of outside directors do not perform better than firms without such boards). In a sample of Japanese firms, several researches show such conflicted results. See Steven N. Kaplan & Bernadette A. Minton, Appointment of Outside Directors to Japanese Boards: Determinants and Implications fro Mangers, 36 J. FIN. ECON. 225, 245-255 (1994) (reporting that top executive turnover increases substantially in years of outside appointment, and firm performance improves modestly after outside appointment); Jun-Koo Kang & Anil Shivdasani, Firm Performance, Corporate Governance, and Top Executive Turnover in Japan, 38 J. FIN. ECON. 29, 44-46 (1995) (finding no significant relationship between firm performance and the outside directors).

10 See FRANKLIN ALLEN & DOUGLAS GALE, COMPARING FINANCIAL SYSTEMS 95 (2000). 11 See Michael C. Jensen & Kevin J. Murphy, Performance Pay and Top-Management

Incentives, 98 J. POL. ECON. 225 (1990) (finding that the pay-performance sensitivity has gradually reduced; CEO wealth changes $3.25 for every $1,000 change in shareholder wealth, most CEOs hold trivial fractions of their firms’ stock, and managerial ownership have declined over the past 50 years); Joseph G. Haubrich, Risk Aversion, Performance Pay, and the Principal-Agent Problem, 102 J. POL. ECON. 258 (1994) (showing that low levels of performance pay according to Jensen & Murphy are not inconsistent with the principal-agent model). But see Brian J. Hall & Jeffrey B. Liebman, Are CEOs Really Paid Like Bureaucrats? 113 Q.J. ECON. 653 (1998) (finding that, virtually all of the pay-performance sensitivity is attributable to changes in the value of CEO holding of stock and stock options, and, as a result, pay-performance sensitivity have risen dramatically during the 1980s and 1990s due to the explosion of stock option issuance).

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reduce agency costs but rather results from such costs.12 The stock options given to CEOs may have negative impact on shareholder value, since stock options in general do not include a penalty when the firm’s performance is poor,13 or it is likely that the details of the plan is badly designed.14 Finally, institutional voices are not so strong. Although several institutional investors have often started proxy contest opposing the issuance of (or seeking the rescission of) poison pills,15 there still remains many barriers, such as such rational apathy, free rider problem, exit option, and conflict of interest inside the institutions.16 Overall, current role of ex ante monitoring schemes is limited.

In Korea, the situation is even worse. Taking into account the controlling

minority ownership structure in Korean corporate groups,17 the governance tools are unable to monitor the controlling shareholders. Although the securities law mandates outside directors for listed companies,18 for instance, there is little evidence that they have something to do with firm performance.19 As far as independence issue is concerned, outside directors are still appointed by top management or, in fact, by controlling shareholders, who are supposed to be monitored. Now, the market for “outside directors” is emerging, and most outside

12 See Lucian A. Bebchuk, Jesse M. Fried & David I. Walker, Managerial Power and

Rend Extraction in the Design of Executive Compensation, 69 U. CHI. L. REV. 751, 783-795 (2002). See also LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION (2004).

13 See Saul Levmore, Puzzling Stock Options and Compensation Norms, 149 U. PA. L. REV. 1901, 1903-1923 (2001) (pointing out that bonus plans and indexed options are superior to conventional stock options).

14 See Bebchuk, Fried & Walker, supra note 13, at 792 (“The devil is in these details. . . . A badly designed option plan might produce significantly less value for shareholders than a plan constructed to maximize shareholder wealth.”).

15 See, e.g., International Brotherhood of Teamsters General Fund v. Fleming, 975 P.2d 907 (Okla. 1999).

16 See JESSE H. CHOPER, JOHN C. COFFEE, JR. & RONALD J. GILSON, CASES AND MATERIALS ON CORPORATIONS, 544-548 (5th, 2000).

17 See Song, supra note 1, at 196-202. 18 At least 25% of board members must be independent outside directors if the

companies are listed on the Korea Stock Exchange. See Korean Securities and Exchange Act § 191-16(1). If the size of listed companies is larger (with assets greater than 2 trillion Won), the mandatory outside directors must be more than 50% of the all directors. See Korean Securities and Exchange Act § 191-16(1); Presidential Decree § 84-23(2). Non-listed companies are not forced to have independent directors, but if they establish the audit committee according to the articles of incorporations, more than two thirds of committee members shall be the independent directors. See Korean Commercial Code § 415-2(2).

19 Cf. Bernard S. Black, Hasung Jang & Woochan Kim, Does Corporate Governance Predict Firms’ Market Value? Evidence from Korea, 22 J.L. ECON. & ORG. 366 (2006) (finding that Korean firms with 50% outside directors have 0.13 higher Tobin’s Q and roughly 40% higher share price).

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directors tend to be passive to avoid being labeled as a “trouble maker.” As a result, effective monitoring by board structure seems to be hardly achieved.

Other ex ante regulations or incentive schemes do not seem to be well

functioning. Audit committees are mandatory for large listed companies,20 but several issues on their status and daily operations are not yet resolved. Stock options were introduced in the late-1990s, but the incentive effect associated with the option structure is not witnessed, mainly because the correlation between firm performance and stock price is not yet firmly established. Institutional investors do not help, due to the relatively small shareholdings and the inherent passivity of financial institutions derived from their diversified portfolios.

What about the market for corporate control? Two major ex post liability

measures for governance failure is corporate litigations and hostile bids. Arguably, when the ownership of the company is dispersed, one of the most important disciplinary mechanisms is the market for corporate control. As widely noted, however, the recent U.S. market for corporate control seems to be paralyzed, due to the pro-management Delaware jurisprudence on the use of poison pill and staggered board.21 Since defensive tactics are perfect and thus the incumbent target managers are able to be fully insulated from the takeover threat, the “disciplinary” function of market for corporate control almost disappeared.

Under the Korean corporate law, by contrast, it is relatively hard for target

management to employ several defensive strategies developed in the U.S.22 Consider, for example, major defensive tactics from the U.S. perspectives: classified or staggered board. A few Korean companies started to adopt staggered board provisions in their charters for the defensive purpose, but they don’t realize how it works. In order for a staggered board to be effective, directors may not be removed unless there is a justifiable cause, and thus shareholders may not pack the board by increasing the number of directors and filling the vacancies.23 Korean Commercial Code provides, however, that two thirds of attending voting

20 See Korean Securities and Exchange Act § 191-17(1); Presidential Decree § 84-23(2). 21 See generally Lucian A. Bebchuk & Allen Ferrell, Federalism and Corporate Law:

The Race to Protect Managers from Takeovers, 99 COLUM. L. REV. 1168, 1179 (1999) (arguing that state competition is likely to produce rules that excessively protect incumbent managers and, as a result, “Delaware law has gradually evolved so as to allow directors . . . to ‘just say no’ to potential bidders with the poison pill defense in place”); Lucian A. Bebchuk, John C. Coates & Guhan Subramanian, The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy, 54 STAN. L. REV. 887, 927-930 (2002) (finding that not a single hostile bid won a ballot box victory against an effective staggered board in the five-year period 1996-2000, and that an effective staggered board nearly doubled the odds of remaining independent for an average target, from 34% to 61%).

22 On bidder’s side, Korea already imported almost all the elements of Williams Act. See Korean Securities and Exchange Act §§ 200-2 (5% reporting obligation), 21-2 to 27-2 (substantive regulation on tender offer), 199 (with Presidential Decree § 84) (proxy rule).

23 See Bebchuk, Coates & Subramanian, supra note 22, at 894.

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shares and at the same time one thirds of voting shares can remove directors “without cause.”24 The corporate charter that provides otherwise is deemed to be void. As a result, obtaining proxy of more than two third—sometimes less than two thirds are enough because all shareholders do not attend the meeting—can eliminate the existing board, whether it is classified or not. Similarly, the white knight arrangements25 or poison pills26 are not available in Korea. In short, Korean big companies might be much more vulnerable to hostile takeovers than the U.S. counterparts; once hostile bids are launched, it is quite hard for incumbent managers to find adequate and costless defensive tactics.

In fact, however, hostile bids are quite rare in Korea, and thus the market

for corporate control almost never exists.27 There are several reasons. First, the controlling shareholders already have their control block of over 40% of shares through pyramids and circular shareholding. Potential buyers do not attempt to start bidding, because they have to buy almost all the remaining shares traded in the market. Second, again, the stock market is under-developed and thus the information about the managerial efficiency is hardly reflected to the stock

24 See Korean Commercial Code §§ 385(1), 434. 25 Korean corporate law stipulates the preemptive right of shareholders; unless the

charter provides otherwise, the shareholders are entitled to receive, pro rata, newly issued shares of the company. The charter allowance of the third-party issuance of shares is restricted to the case where the company has certain “business purposes” such as R&D or capital raising. See Korean Commercial Code § 418. If, therefore, the incumbent managers adopt the white knight strategy, they must bear the high risk of the court’s invalidation for the reason that the tactic is adopted for the purpose of mere defense, which does not fall into the “business purpose” of the company.

26 It is widely accepted that pills in the original format—dividends of options to buy issuer’s shares at negotiated price—cannot be issued in Korea. The corporate law does not allow the company to pay dividends except in the form of cash payment, and thus the rights cannot be returned to shareholders as dividends. In addition, the issuance of warrants—call options to buy issuer’s shares—is believed to be prohibited under the law. Even if the law is amended to allow such direct issuance, still such transactions are likely to be subject to strict scrutiny and as a result may well be invalidated by the court, primarily due to the discriminative feature of pills. Taken together, the most powerful defensive tactic in the U.S. is not available in Korea.

27 In fact, lack of hostile bids is distinctive feature of several countries, such as Germany and Japan, in which corporations are owned by controlling families. See Julian Franks & Colin Mayer, Corporate Ownership and Control in the U.K., Germany, and France, in STUDIES IN INTERNATIONAL CORPORATE FINANCE AND GOVERNANCE SYSTEMS: A COMPARISON OF THE U.S., JAPAN & EUROPE, 281, 292-293 (DONALD H. CHEW ED., 1997) (suggesting several explanations for the low level of hostile takeovers in Germany; bank control, voting right limitations irrespective of size of the shareholding, and difficulty in removing members of the supervisory board); J. MARK RAMSEYER & MINORU NAKAZATO, JAPANESE LAW: AN ECONOMIC APPROACH, 121-122 (1999) (mentioning legal barriers, cross-shareholding, and transformation of hostile bids into friendly ones).

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price.28 In such case, bidders have difficulties in identifying the target, and, even if they are more efficient than current incumbent managers, there is no guarantee that the market will know about it after they acquire the target. Finally, the less sophisticated legal system is another problem. The ineffective takeover market deters the development of a sophisticated judiciary and legal doctrines, and this failure of judicial development, in turn, restricts the effectiveness of the market for corporate control in Korea.

Given such situation in which the ex ante monitoring or incentive

mechanisms inherently or practically defective and the market for corporate control is hard to provide disciplinary function, the social gains from corporate litigations must be large. Korea has both derivative suits and class actions, and the latter is recently adopted.

II. COMPARATIVE STUDY: CORPORATE LITIGATIONS IN KOREA

1. Derivative Suits

A derivative suit is a unique feature of the U.S. law. The German corporate law, from which the Korean and Japanese corporate law were originated, did not know this—instead, shareholders are only able to require auditors to bring a lawsuit against directors. It follows that the statutory framework of derivative suits in Korea, Japan, and the U.S. is seemingly identical, with minimal and negligible distinctions. Despite such similarities, it is puzzling that the different practice of derivative suits in those countries.

To illustrate, consider the Japanese cases. Japan also has witnessed almost

no derivative actions since its adoption in 1950. Shareholders in Japan filed only fewer than 20 derivative suits from 1950 to 1990.29 In 1993, Japan reduced the filing fees to about $80 (8,200 Yen), and such change had brought about an explosion in derivative litigation.30 Relying on this fact, commentators tend to believe that the reducing litigation fee may “cause” such explosion, but it is not convincing.31 Korea has fixed the filing fees at some nominal amount for a long

28 See Henry G. Manne, Mergers and the Market for Corporate Control, 73 J. POL.

ECON. 110, 112-114 (1965) (arguing that the most “fundamental premise underlying the market for corporate control is the existence of a high positive correlation between corporate managerial efficiency and the market price of shares of that company”).

29 See Mark D. West, The Pricing of Shareholder Derivative Actions in Japan and the United States, 88 NW. U.L. REV. 1436, 1438 (1994).

30 See Mark D. West, Why Shareholders Sue: The Evidence from Japan, 30 J. LEGAL STUD. 351, 352, 355-356 and table 1 (2001) (reporting that 84 suits were pending in 1993, but there were 174 suits in total by the end of 1996, and 286 suits by the end of 1999, including 95 filed in 1999 alone).

31 See also MILHAUPT & WEST, supra note 5, at 10 (mentioning that the increase in the number is still puzzling “given the continuing lack of shareholder incentives to sue”).

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time since early-1990s; about $50 (50,000 Won) prior to the financial crisis, and currently about $230 (230,000 Won).32 Nevertheless, shareholders in Korea are very reluctant to bring a lawsuit. As a matter of fact, the filing fees have never been a critical issue in Korea; the nominal increase in filing fees did not attempt to block the lawsuits, but just to catch up the general price increase. Setting aside the effect of the filing fees, what prevents Korean shareholders from bring a lawsuit? What exactly is it that Japan and the U.S. have, but Korea does not have? This Part will be devoted to compare the basic legal structures of derivative suits between Korea, Japan, and the U.S.

A. Who Can Bring a Suit?

Traditionally, the minimum shareholding requirement imposed on a plaintiff has been regarded as the most significant barrier that prevents shareholders from bringing a derivative suit.33 Prior to the financial crisis, the statutory threshold to bring a suit was 5% of shares of the company. Comparing to the U.S.34 and Japan,35 where a shareholder with only one share may bring a derivative suit, the 5% requirement was blamed for paralyzing the derivative suits. Considering the fact that even the controlling families in Korean chaebols directly own, on average, less than 10% of controlled firms, the threshold of 5% seemed to be too high. Right after the financial crisis in 1997-1998, therefore, the shareholding threshold for filing a derivative suit was dramatically reduced to 0.01% in case of listed companies.36 It is not clear that such threshold of 0.01% is still significant hurdle for derivative lawsuits.

Another seemingly barrier to bring a suit is a holding period requirement,

32 See Korean Civil Action Filing Fees Act § 2(1) (providing that if the litigated amount

is more than 10 million Won and less than 100 million Won, the filing fee is “the litigated amount × 45 / 10,000 + 5,000 Won”); Supreme Court Regulation on Civil Action Filing Fees §§ 15(1), 18-2 (providing that, regardless of the amount of damages alleged, 50 million and 100 Won is regarded as the litigated amount of derivative suits). The filing fees are thus calculated as 50,000,100 × 45 / 10,000 + 5,000, or roughly 230,000 Won. Prior to the year of 2001, the same provisions of the Act and Regulation provided that the litigated amount of derivative suits were 10 million and 100 Won, and the ratio to be multiplied to this amount is 5 /1,000. As a result, the filing fees prior to the crisis were 10,000,100 × 5 / 1,000, or roughly 50,000 Won.

33 See Kon-Sik Kim & Joongi Kim, Revamping Fiduciary Duties in Korea: Does Law Matter to Corporate Governance, in GLOBAL MARKETS, DOMESTIC INSTITUTIONS: CORPORATE LAW AND GOVERNANCE IN A NEW ERA OF CROSS-BORDER DEALS 373, 386 (CURTIS J. MILHAUPT ED. 2003).

34 See, e.g., REV. MODEL BUS. CORP. ACT § 7.41 (no limitation). 35 See Japanese old Commercial Code § 267(1), replaced by new Corporate Code § __

(no limitation). 36 See Korean Securities and Exchange Act § 191-13(1). In case of non-listed companies,

the shareholding threshold was also reduced to 1%, which seems to be still high. See Korean Commercial Code § 403(1).

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which was only found in Japan.37 The Korean Securities and Exchange Act requires that a shareholder should hold shares “continuously” for 6 months before bringing a suit.38

On the other hand, however, Korean corporate law, like Japanese law,

does not provide “contemporaneous shareholder rule,” which is universal in the U.S. corporate law.39 Under this rule, the plaintiff shareholder must have been a shareholder “at the time of the alleged wrongdoing.” There are two rationales for the contemporaneous shareholder rule. One is a concern with individuals purchasing shares simply for the purpose of bringing a frivolous suit. The other is that, since the market price reflects the losses that the directors’ wrongdoing might incur, granting recovery to individuals who buy stock after wrongdoing damaged the corporation allows them to obtain a windfall.40 Since there is no such rule in Korea, the individuals can bring a suit simply by purchasing a few shares—but the amount must be over 0.01% of total shares and they must wait for 6 months after purchasing shares—after noticing managerial wrongdoing in a listed company, although nobody has attempted to do this. Arguably, the purpose might be the same. They aim at preventing a frivolous suit through different institutions: the holding period requirement in Korea and Japan and the contemporaneous shareholder rule in the U.S.

B. How Can Board Interrupt?

Under Delaware corporate law, a plaintiff shareholder, prior to bringing a

suit, must make a demand on the corporation’s board of directors to take action, “unless the demand would be futile.”41 In Korea, on the contrary, demand on board is universal,42 as the RMBCA and the ALI’s Principles of Corporate Governance provided,43 and a plaintiff shareholder should wait for 30 days. Only if the demand and waiting 30 days for board’s response might cause the company

37 See Japanese old Commercial Code § 267(1), replaced by new Corporate Code § __

(also six months). 38 See Korean Securities and Exchange Act § 191-13(1). In case of non-listed companies,

instead of requiring higher shareholding ratio, there is no requirement regarding holding period. See Korean Commercial Code § 403(1).

39 See, e.g., DEL. CODE ANN. tit. 8, § 327; CAL. CORP. CODE § 800(b)(1); N.Y. BUS. CORP. LAW § 626(b); REV. MODEL BUS. CORP. ACT § 7.41(a).

40 See FRANKLIN A. GEVURTZ, CORPORATION LAW, 396-399 (2000) (concluding that “the contemporaneous shareholder rule is a mistake”), ROBERT C. CLARK, CORPORATE LAW, 650-652 (1986) (mentioning that “it is difficult to justify the continued existence of the contemporaneous ownership rule”).

41 See GEVURTZ, supra note 40, at 401. 42 See Korean Commercial Code § 403(1). 43 See REV. MODEL BUS. CORP. ACT § 7.42; American Law Institute, Principles of

Corporate Governance § 7.03.

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“irreparable damage,” shareholders can bring a suit without demand on board.44 Put another way, so-called “demand required, demand excused” distinction in Delaware jurisprudence has not been adopted in Korea and Japan; even though the demand would be “futile,” shareholders must make a demand unless irreparable harm to the corporation would be incurred. The result is that the directors have enough time to take defensive measures at corporate expenses, and a lawsuit is at least delayed for 30 days.

On the other hand, most part of the procedural complexities in relation to

the demand issue in the U.S. derivative suits does not exist in Korea. In particular, the board is almost inept to bar the complaint from proceeding to the court. The U.S. board has two major tools to interrupt shareholders and prevent them from proceeding; refusal to bring a suit and special litigation committees. (1) The board may simply refuse to take action. Applying business judgment rule to such refusal, courts held that the litigation might go forward if, for example, the plaintiff can prove directors’ conflicts of interest or bad faith.45 Such proof might be readily available, but in any event, a shareholder in Korea is able to proceed without showing directors’ conflicts of interest or bad faith.46 (2) The U.S. corporate management can ward off derivative suits by appointing special litigation committees. Since mid-1970s, such committees, almost without exception, have concluded that the derivative suits were not in the corporation’s best interest,47 and perhaps played a major role to prevent a frivolous suit. In Korea, however, such practice is not expected to emerge in the near future.

Taken together, the U.S. shareholders must be concerned about the

strategies that the board can employ to drop the suit, while in Korea and Japan, the demand requirement is merely procedural. A shareholder has to wait for several days, but after doing this, the suit automatically proceeds. The only way for the Korean company’s board to bar a derivative suit is to accept the demand and have the company itself file the suit. In those respects, a derivative suit is more easily brought in Korea (Japan as well) than in the U.S.

C. Litigation Costs

To bring a suit, a plaintiff shareholder incurs filing fees—currently about $190—and attorney’s fees. Theory tells that such costs may significantly prevents a shareholder from suing directors, since it is the injured company that receives the actual recovery, a plaintiff shareholder can obtain only a proportional—

44 See Korean Commercial Code § 403(4). 45 See GEVURTZ, supra note 40, at 408; CLARK, supra note 40, at 644. 46 See Korean Commercial Code § 403(3). 47 See GEVURTZ, supra note 40, at 412. For judicial review of the committee’s

recommendation to drop suits, see Auerbach v. Bennett, 47 N.Y.2d 619 (1979) (minimal review); Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) (two-step test).

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typically de minimis—benefit from a “corporate” recovery in a suit. Accordingly, the U.S. rule is that a shareholder “prevailing” in a derivative suit should be fully reimbursed by the company for the filing fees and attorney fees incurred. Economically, the full reimbursement of litigation costs by the corporation is equivalent to the imposition of litigation costs on all the shareholders, pro rata, and therefore free-rider problem can be resolved. From the same reasoning, therefore, the reimbursement of filing fees and attorney fees is statutorily provided in Korea48 as well as in Japan.49

Nevertheless, the shareholders and attorneys in Korea still have to bear a

significant risk in association with filing a derivative suit. (1) The reimbursement of litigation costs is awarded only if a plaintiff prevails. Should he or she fail, the company is not obliged to pay the cost incurred, even though the suit was brought in good faith. Combined with the cost allocation rule mentioned below, such possibility raises significantly the expected cost of bringing a suit. (2) The reimbursement is in principle limited to the “reasonable or appropriate amount,” but the scope which is deemed to be reasonable is not yet clear. Current level of costs that is allowed to the legally justifiable litigation costs is provided by the Supreme Court Rule,50 and thus if plaintiff attorneys are paid more than this Rule prescribes, they are unlikely to be fully reimbursed. Most notably, this Rule calculates the litigation costs on the basis of the amount pursued in a suit,51 and does not employ any special method—like the “lodestar” method in the U.S. cases—for a derivative suit. Since a derivative suit is perceived to be quite time-consuming that an ordinary suit of the same amount pursued, the final amount of attorney fees calculated by this Rule may be lower than those numbers by the lodestar method. Thus, the attorneys are subject to risk of not being fully compensated.

It should not be ignored that a plaintiff shareholder in Korea bears another

risk in relation to litigation costs. Korea follows the British rule in allocating the litigation costs; a plaintiff losing the suit must pay the litigation costs—including attorney fees—reasonably incurred by the defendant.52 As a result, the uncertainty with regard to the litigation costs in Korea may raise the expected costs of filing a derivative suit for two reasons: (1) if a plaintiff shareholder wins, he or she is not sure of being fully reimbursed; and (2) if, on the other hand, a shareholder loses,

48 See Korean Securities and Exchange Act § 191-13(6) (reimbursement of “full”

litigation costs); Korean Commercial Code § 405(1) (reimbursement of “reasonable or appropriate” litigation costs).

49 See Japanese Commercial Code § 268-2(1), replaced by new Corporate Code § __. 50 See Korean Civil Procedure Act § 109(1). 51 See Supreme Court Rule on the Calculation of Reasonable Litigation Costs § 3(1). 52 See Korean Civil Procedure Act § 98. The British rule does not apply if the parties

agree to settle. In case of settlement, American rule—each party bears its own costs—applies. See Korean Civil Procedure Act § 106.

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he or she should face the British rule and bear the litigation costs reasonably incurred of both parties.

On the other hand, mainly due to a concern about frivolous suit, roughly

one third of the U.S. states require that the plaintiff shareholder should post security to cover the expenses that the corporation might incur. New York enacted the first security for expenses statute in 1944,53 but Delaware did not follow yet. Although Korean corporate law is not much concerned about the abusive practice of derivative suits, the security of expense clause has been incorporated in the statute since its origin.54 That is, the court may, at the request of the defendant directors who proved that the suit was brought in bad faith, order the plaintiff to post adequate amount of security for expenses. To be sure, a shareholder who brings a meritorious suit does not have to post security, but in actuality, it depends primarily on the court’s interpretation of the “bad faith” of a plaintiff. Still, there are a lot of ambiguities here.

D. Summary

The following table summarizes the basic legal framework of derivative suit system set forth above, with the details omitted. <Table 1> Comparison of Statutes

United States Japan Korea Minimum Shareholding X X 0.01%

Holding Period X 6 Months 6 Months Contemp. Shareholder O X X

Demand on Board Futility Test 30 Days Delay 30 Days Delay If Board Refuses BJR Applies Can File Suit Can File Suit

Litigation Committee O X X Filing Fees $100 (Fixed) $80 (Fixed) $190 (Fixed)

Attorney Fees if Prevail Reimbursed Reimbursed Reimbursed Cost Allocation American Rule American Rule British Rule

Security for Expenses O O (if bad faith) O (if bad faith)

As stated above, the basic structure of litigation system looks quite similar. This is not surprising, though, because Korea and Japan imported the U.S. model with no substantial modifications. Only notable distinction between Korea and Japan is that Korean law requires a shareholder to possess more than 0.01% of total shares. Compared to the U.S. system, on the other hand, a shareholder in Korea has several advantages; he or she does not have to be a contemporaneous shareholder, the possibility for the board to block the suit is very limited, and finally the court may decide in favor of the plaintiff with regard to the security

53 See N.Y. BUS. CORP. LAW § 627. 54 See Korean Commercial Code § 403(7), 176(3), (4).

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deposit. Only disadvantages of a shareholder of Korean company are, again, the minimum holding requirement and holding period of six months.

Thus, an immediate response would be, why derivative suits are not

brought in Korea, while the U.S. and Japan have trouble with too many suits? Again, the 0.01% holding requirement and uncertainties in association with litigation costs cause that much trouble to a shareholder who intended to bring a derivative lawsuit? We will revisit this issue in Part III.

2. Securities Class Actions

What about the class actions? On December 22th, 2004, the National Assembly of Korea passed the Securities Class Action Act that came into effect from the January 1st, 2005. Was it a good idea? As a matter of fact, a securities class action has always been controversial even in the U.S. legal academia. The externalities from the omission or misrepresentation of material information are in nature purely pecuniary,55 and thus allowing a buyer of a security to be compensated by the company may result merely in a windfall to the seller, and vice versa. An investor who already diversifies his or her investment could be worse off if a class action system is adopted. From ex post point of view, indeed, the description made a decade ago by professor Alexander still holds.

“. . . payments by the corporation to settle a class action amount to transferring money from one pocket to the other, with about half of it dropping on the floor for lawyers to pick up. Such transfers are not in the economic interests of continuing shareholders.”56

Such skeptical view—mainly stressed by the business circle—had

prevented the Korean government from adopting the class action system for several years since the financial crisis. Setting aside the theoretical issues, needless to say, the strongest arguments of the opponents included the abusive practices such as a frivolous suit or collusive settlement. If, the argument goes, it is true that the U.S. has experienced such trouble with class actions and thus enacted the Private Securities Litigation Reform Act of 1995, or PSLRA, to change the abusive practices, Korea’s sudden jump into the class action system might not be desirable. Another group of the opponents placed emphasis on the difference of legal and cultural environment. In addition to the traditional “common law v. civil law” distinctions, for instance, they argued that the class action is the unique feature of the U.S. legal system, and it would inevitably fails to be in harmony with the Korean civil procedure law, under which it is strictly prohibited for any person to exercise or dispose the other’s legal entitlements.

55 See DAVID D. FRIEDMAN, LAW’S ORDER: WHAT ECONOMICS HAS TO DO WITH LAW

AND WHY IT MATTERS 35 (2000). 56 See Janet C. Alexander, Rethinking Damages in Securities Class Actions, 48 STAN. L.

REV. 1487, 1503 (1996).

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Arguably, the most critical issue was whether the newly introduced class

actions would be able to have a disciplinary effect against corporate directors. While the proponents argued that new system could enhance the transparency and accountability of corporate management,57 business sectors exaggerated the malicious effect of a class action by saying, for instance, that the filing a suit is likely to destroy the company’s reputation in the market and thus eventually leads it to go bankrupt. A lot of seminars, conferences, and even moot courts were held in preparation for the defense against class actions, and large companies are gradually equipped with expanded in-house legal counsels. Unfortunately, however, both sides turned out to be wrong. As of now, no movement toward a class action was detected; no class action has been filed, and no law firms or private attorneys voluntarily entered into this business.

A. Limited Applicability

Arguably, one of the most important features of the Securities Class

Action Act is that the Act in fact resulted from a social compromise. Since it was the first time the class action was enacted in the East Asian countries, and on the other hand, there were a lot of concerns about the negative impact of the new legislation, the Act must incorporate several provisions—mostly designed after the model of PSLRA of 1995—to curtail the abusive practices.

In this context, the Act provides that a class action may be brought in very

limited circumstances,58 such as (1) violation of duty of disclosure in the public offering,59 (2) negligence of periodic reporting by the registered company,60 (3) market manipulation or insider trading, and (4) fraudulent audits. These restrictions are not found even in the PSLRA of 1995, and it can be revealed that the government wanted to implement the institution very carefully. In fact, the original bill went further by stating that a class action may be brought only against the company with assets of two trillion Won—equivalent to roughly two billion U.S. dollars—or more,61 but it was argued that such type of restriction was so extraordinary and the size of assets always fluctuates. Moreover, it should be

57 Enhancing the transparency of corporate management was also mentioned as a purpose of the Act. See Korean Securities Class Action Act § 1.

58 See Korean Securities Class Action Act § 3(1). 59 See Korean Securities Exchange Act § 14. This provision is a “catch-all” clause, and

includes all the liabilities of §§ 11, 12(a), 12(b) of the 33 Act in the U.S. except that the buyer of a security in the secondary market does not have standing for a plaintiff.

60 See Korean Securities Exchange Act § 186-5. The periodic reporting like 10-K or 10-Q is mandatory for all listed companies in the Korean Stock Exchange market or KOSDAQ market. Article 186-5 is a Korean version of the Rule 10b-5, with limited applicability.

61 On June 2004, the number of the company with assets of two trillion Won or more is only 66; 63 companies are listed in the Korean Stock Exchange and 3 companies in the KOSDAQ.

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taken into account that the securities fraud tends to be more prevalent among the smaller public companies. Since it was very hard to find the policy justification for such unusual restriction, the Act discarded this provision. Instead, however, the Act did not apply to such listed companies until the January 1st, 2007,62 except for the cases of manipulation or insider trading.

Immediately after the approval of the Act, the debate about the

applicability of the Act to accounting fraud was heated. Several scholars pointed out that it is statutorily feasible for the company which once committed accounting fraud long time ago, say, on 1980 to be held liable to the shareholders of the year 2006, because the effect of the fraud in 1980’s financial statements is likely to be reflected to the 2006’s statements. For those reasons, they exaggerated, unless the company discloses the accounting fraud committed in the past and then takes the “reverse” accounting process, it may get into trouble of being held liable for accounting fraud in a class action. To be sure, it does not make any sense, because the Act explicitly states that a class action may be brought to the action “that is committed after the Act comes into effect.”63 A class action cannot be brought against the company which committed the accounting fraud in 1980.

On interpretation of this clause, however, it was argued that reporting the

2006’s financial statement without correcting the reflection of 1980’s false information may still be regarded as “the action that is committed in the year of 2006.” This interpretation is not convincing, because if it were the case and the Act prohibited an investor from filing a class action, he or she was able to bring an ordinary securities lawsuit even before the enactment of the Securities Class Action Act. That is, the introduction of class action has nothing to do with the company’s liability. Nevertheless, the Act was amended in March 2005 to take into account such concerns, and explicitly provided that the accounting fraud committed in the past will not be subject to a class action if the company discloses the accounting fraud and takes the “reverse” accounting process to correct it by the December 31, 2006.64 Ironically, however, few companies did it so far, and thus this amendment may end up with enabling a shareholder to bring a class action if the company committed accounting fraud for once in the past, because this provision assumes that such lawsuits are perfectly legal—what a silly mistake!

B. Class Members and Opt-Out Provision

The Act considered three issues to determine a “class.” That is, (1) the

basic structure of class formation is designed after the U.S. model, or Rule 23 of the Federal Rules of Civil Procedure, (2) the inconsistency of the “class” concept with the principles of civil procedure law should be minimized by providing the

62 See Korean Securities Class Action Act, Appendix § 3. 63 See Korean Securities Class Action Act, Appendix § 2. 64 See Korean Securities Class Action Act, Appendix § 4.

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notice requirements more precisely, and again, (3) several provisions are inserted to prevent the abusive lawsuits.

First of all, under Rule 23 of the Federal Rules of Civil Procedure, for a

class action to be maintained, the class should satisfy several requirements provided in Rule 23(a) (prerequisites) and Rule 23(b). These are also found in the Korean counterpart. For instance, the class members must be numerous;65 the questions of law or fact should be common to class members;66 the lead plaintiff should fairly and adequately protect the interest of the class;67 and finally, a class action is superior to other measures for protection of the interest of class members and efficient adjudication of the dispute.68 Thus, it is not exaggerating to say that the basic structure of Korean class action is modeled on the U.S. law.

Copying was easy, but the government had to coax the opponents into

accepting the bill. Legal scholars, for instance, were arguing that it is in violation of the principles of civil procedure to extend les judicata, binding force of the judgment, to the persons who did not take part in the lawsuit or did not acknowledge the filing of the suit.69 To be sure, this is one of the core elements of class actions, but it is also true that such extension is inconsistent with the Korean adversary system. Taking the criticism, the Act allows the members to opt out from the class; the members may file a written declaration of exclusion with the court.70 In order for the members to decide whether to remain or not, they must be notified the filing of a class action, and thus the Act provides details about notifications.

The problem with the notification requirements is that they are likely to

increase the cost associated with filing of a suit, without substantial benefits. The notification should be made by ordinary mail to the members, and the court is obliged to make every effort to identify the addresses,71 but it does not make sense. The class action assumes the situation in which the individual damages are so small that the each victim has no incentive to sue. That is, even if the individual member is notified the filing of an action, he or she still has no incentive to think about it. Moreover, opting-out from the class—contrary to the legislative intent—does not mean that the member preserves his or her right to sue. Rather, because the member won’t file an individual suit, there will be no recovery forever.

65 See Fed. R. Civ. P. § 23(a)(1); Korean Securities Class Action Act § 12(1) 1. The

minimum size of the class is also provided. See infra note 73. 66 See Fed. R. Civ. P. § 23(a)(2); Korean Securities Class Action Act § 12(1) 2. 67 See Fed. R. Civ. P. § 23(a)(4); Korean Securities Class Action Act § 11(1). 68 See Fed. R. Civ. P. § 23(b)(3); Korean Securities Class Action Act § 12(1) 3. 69 See Korean Securities Class Action Act § 37. 70 See Korean Securities Class Action Act § 28(1). 71 See Supreme Court Rules on Securities Class Action § 15.

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Acknowledging this, no one will file a written declaration of exclusion. So, why should the court have to incur large cost to notify individual investors? Arguably, lowering the cost incurred in notifying investors should be preferred to protecting individual right to sue, and perhaps the notification by an announcement in the newspaper alone might be sufficient for that purpose.

Finally, the minimum class size is inserted to prevent the abusive lawsuits.

The Rule 23 in the U.S. only requires that the class be “so numerous that joinder of all members is impracticable,”72 but the Act requires that the class consist of 50 members or more and the class hold at least 0.01% of the total number of securities issued by the defendant company.73 This provision reminds us of the minimum shareholding requirement in case of a derivative suit.74 Again, it seems obvious that the legislators were unreasonably obsessed with the abuse issue.

C. Lead Plaintiff and Lead Counsel

The qualifications and restrictions on lead plaintiffs and lead counsels

include the most controversial issues through the enactment of the Act. As widely noted, the PSLRA of 1995 in the U.S. reformed the securities class actions in various aspects, especially in relation to the lead plaintiff and lead counsel, primarily in order to prevent “professional plaintiffs” from filing a frivolous suit, and to encourage the institutional investors to actively participate in the class action.

In the U.S. class actions, several provisions serve this purpose. (1) The

lead plaintiff should file a sworn certification with the court, basically saying that he or she did not purchase the securities only for the purpose of bringing a class action.75 (2) A person may be a lead plaintiff in no more than five class actions for any three years.76 (3) The court must determine who is most able to represent the interests of class members, and in such determination of the court, the person who has “the largest financial interest” in the suit should be presumed to be the most adequate plaintiff.77 (4) If a lead counsel directly owns or otherwise has a beneficial interest in the securities that are the subject of the litigation, and therefore the conflict of interest is significant, the court may disqualify the attorney.78

72 See Fed. R. Civ. P. § 23(a)(1). 73 See Korean Securities Class Action Act § 12(1) 1. 74 See supra note 36 and accompanying text. 75 See 33 Act § 27(a)(2)(A); 34 Act § 21D(a)(2)(A). Note that, hereinafter, I use neither

the full name of the 33 Act and 34 Act nor the official U.S.C. number, to cite the securities law provisions, for readers might be more familiar with this notation.

76 See 33 Act § 27(a)(3)(B)(vi); 34 Act § 21D(a)(3)(B)(vi). 77 See 33 Act § 27(a)(3)(B)(i), (iii); 34 Act § 21D(a)(3)(B)(i), (iii). 78 See 33 Act § 27(a)(9); 34 Act § 21D(a)(9).

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Almost same provisions for all of the above are found in the Korean Securities Class Action Act,79 with very slight modification and addition. Contrary to the U.S. class actions, for instance, the number of class actions that may disqualify the lead plaintiff if he or she has been involved in for any three years is reduced to three, and such restriction is applied to lead counsel as well. In particular, the restriction that prohibits the lead counsel from bring more than three class actions during any three year period has been blamed for the reason of impeding the development of experienced professional class action law firms. Arguably, it is almost inconceivable for the current major law firms in Korea to bring a class action as a lead counsel against their client companies, and thus the only way for a class action to be brought is encouraging small law firms to specialize in this area. Thus, the above claim seemed quite convincing, and perhaps the Act should have given more incentives to the smaller law firms.

More fundamental question might be whether such kinds of strict

restrictions were in fact necessary, given the different legal and soial environments between the U.S. and Korea. These provisions were of course based on the opponents’ perception that the introduction of class action system might have a huge impact on the daily operation of business circles and thus the abusive lawsuits are also quite likely in Korea. Contrary to this expectation, however, no class action is ever filed. Even several attorneys who work for several NGOs often say that they don’t have any intention to engage in the class action business, because many restrictions were already imposed. Perhaps the real effect of the Act is not to promote litigations, but to toll the death knell for them. We will return to this issue in Part III.

D. Litigation Costs

The class actions in Korea are likely to impose a huge financial burden to

lead plaintiffs or lead counsels. First of all, they have to incur filing fees. The Act does not provide the flate rate; instead, the filing fees are in principle determined according to the amount pursued like ordinary lawsuits. The flat rate was not adopted, because a class action was perceived to be merely a suit in which investors are pursuing “their own” damages—just like ordinary lawsuits—and moreover the cases are generally more complicated. Of course, considering the

79 (1) The member who wishes to be a lead plaintiff should file an application that says

he or she did not purchase the securities only for the purpose of bringing a class action or at the request of the attorney. See Korean Securities Class Action Act § 10(3), 9(2). (2) A person who is involved as a lead plaintiff or lead counsel in three or more class actions for recent three years may not be a lead plaintiff or lead counsel. See Act § 11(3). (3) The lead plaintiff should be a person who is able to adequately represent the interests of class members, such as the person who has the largest financial interest in the suit. See Act § 11(1). (4) If a lead counsel directly owns or otherwise has a beneficial interest in the securities that are the subject of the litigation, and therefore the court determines that the conflict of interest is significant, he or she may be disqualified. See Act § 5(2). The emphasis is added by the author to show the distinction.

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fact that the amount pursued in a class action is generally large, the Act allowed a 50% discount off the regular fees, and placed a cap of 50 million Won—equivalent to 50,000 U.S. dollars.80 In comparison with hhe flat rate of $190 in a derivative suit, however, this amount is still so large as to abolish a possible try of filing a class action.

Another financial burden is a payment of expenses, which should be paid

in advance. At the beginging stage of the discussion, the government tried to require the plaintiff to post security to cover the damanges that the company might suffer, just as provided in a derivative suit, and original proposal of the Act contained such provision. Faced a lot of criticism from the NGOs, however, final bill did not adopt this requirement. Instead, the plaintiff must pay in advance the costs incurred in court’s notices to the public and appraisal process in the lawsuit.81 In general, the costs incurred in a class action are borne by the attorney, and they are compensated by the contingent fee arrangement if the plaintiff prevails. Taken together, therefore, the level of the initial investment which attorneys have to make to file a class action is not negligible.

E. Summary

As examined above, the PSLRA of 1995 in the U.S. was imported word

by word into the Korean Class Action Act. Given the ineffective derivative suit system as described previously, the emphasis of designing of new class action system should have been placed on how it could be structured to effectively discourage managers from engaging in wrongdoings. The finally approved Act, however, heavily adopted so-called “anti-abuse” provisions that will effectively discourage investors from filing a suit. In terms of preventing a frivolous suit, the Act went further than the PSLRA of 1995.

III. DISCUSSION

Despite the above statutory similarities or advantages in comparison with

the U.S. and Japan, Korea has not witnessed any “explosion” of derivative suits. Although the filing fees have been a fixed amount of $50 to $230 since 1992,82 no derivative suit had been filed for 5 years since then. Also, no class action has been brought since the enactment of Securities Class Action Act. The first question therefore should be why there is almost no corporate litigation in Korea. 1. Few Derivative Suits

The legal environments of fiduciary duty have been dramatically changed since the financial crisis, mainly through the active filing of lawsuits by the PSPD.

80 See Korean Securities Class Action Act § 7(2). 81 See Korean Securities Class Action Act § 16. 82 See supra note 32 and accompanying text.

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In fact, the PSPD filed the first derivative suit in Korean history in 1997 against the directors and officers of Korea First Bank. In this case, Korea First Bank made a decision to lend large amount to Han-Bo Steel, which went bankrupt in early-1997, and minority shareholders alleged that the directors and officers of the bank violated their duty of care (no investigation on the overall risk of Han-Bo Steel) and duty of loyalty (bribery from Han-Bo Steel). One year later, the Seoul District Court rendered a decision that the former directors are liable,83 and finally the Supreme Court endorsed it.84

In 2001, another high-profile derivative suit was reviewed by the court;

lawsuit against Samsung Electronics brought by, again, the PSPD. It was filed in 1998, and the plaintiffs alleged that the controlling shareholder and directors of Samsung Electronics are liable for breach of duty of care in acquiring a company, which eventually went bankrupt. The Soowon District Court also held that they are liable,85 and, although the specific amount of damages was sifginficantly reduced, such liability of the directors was also recognized by the Supreme Court decision.86 This case might be called a Korean version of Van Gorkom,87 because in making a takeover decision the board members, like the Trans Union managers, were not informed on the risk of a target companay, and as the court particularly emphasized, the acquisition was very hastily approved.88

In addition to these two high-profile cases, two or three more cases were

closed without drawing attention from public, and several cases are pending at the district court level. Overall, derivative suits have been very rarely brought since the financial crisis.

Admittedly, the above two cases—First Korea Bank and Samsung

Electronics—had a great impact on the business law and practices, and the substance of fiduciary law now in Korea is quite different from what it was prior to these two cases. But just two is so small. Contrary to the complaint from the business sector, the number of derivative suits is too small for corporate management to be threatened. Most importantly, the derivative suits—and, if any, the class actions—were not initiated by investors or entrepreneurial lawyers, but rather by the PSPD. Arguably, there would have been no derivative suit but for the PSPD. They filed a suit not for the pecuniary reason, but rather with a mission to cure Korean corporate governance system. Although the activities performed by the PSPD have been generally evaluated more successful than expected in the

83 See Seoul District Court, 97 Ga-Hap 39907 (July 24, 1998). 84 See Supreme Court, 2000 Da 9086 (March 15, 2002). 85 See Soowon District Court, 98 Ga-Hap 22553 (December 27, 2001). 86 See Supreme Court, 2003 Da 69638 (October 28, 2005). 87 See Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). 88 For detailed description of the above two high-profile cases, see Kon-Sik Kim &

Joongi Kim, supra note 33, at 389-392.

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beginning, it lacks human and financial resources to monitor all the major companies in Korea. Thus, the PSPD adopted a strategy, which turned out to be quite smart, of bringing a small number of lawsuits against the limited number of large corporate groups like Samsung, Hyundai, or LG. The controlling shareholders and managers of other corporate groups are still free from the threat of litigations.

2. Litigation Costs and Legal Professions

Why are the Korean practices different? One of the candidates, perhaps the most notable one, is the litigation cost structure, and commentators tend to simply suggest that the reduction of these costs may encourage people to file a suit. The deterrent effect of the litigation costs were briefly discussed in Part II, but this cannot fully explain the differet practices across the countries.

The derivative suits and class actions are different forms of remedies in

terms of the legal structure, but from the economic perspectives, they have much in common. Perhaps most notably, both of them are the lawsuits in which the plaintiff has to incur his or her own costs to protect other investors’ interest. Obviously, a shareholder lacks incentives to file a derivative suit even if he or she knows about the managerial wrongdoing, because a shareholder should bear the total litigation costs but is only able to obtain a fractional benefit of increase in firm value. Since each shareholder has only a small portion of shares, he or she is not willing to take part in the suit unless the costs are minimal or negligible. The incentive structure associated with filing a class action, in which a lead plaintiff brings a lawsuit on behalf of other class members, is just the same. Even though the litigation costs are not too high, the shareholders still have to bear such costs that might be higher than a fractional benefit from the suit, and thus have little incentive at all. Then, what is the convincing argument for explaining the “explosion” of corporate litigations in the U.S. and Japan?

Cultural difference is often suggested, but the argument cannot stand on

the solid ground.89 When there was no shareholder litigation in Japan, for instance, the belief that Japanese people have an “inherent” aversion to litigation is remarkably pervasive among scholars, but such observation turned out to be false. The “culture” argument does not explain the sharp increase in the number of derivative suits of Japan since 1993, because it is unreasonable to believe that

89 See West, supra note 29, at 1439-1441 (“Ending the inquiry with a cultural

explanation avoids the next logical query; namely, why does culture dictate nonlitigiousness, if it does at all? If this second-order question remains unanswered, a satisfactory response to the primary inquiry is impossible.”); J. Mark Ramseyer, Takeovers in Japan: Opportunism, Ideology and Corporate Control, 35 UCLA L. REV. 1, 39-40 (1987) (“Cultural values are fragile things. . . . Whether hostile takeovers will eventually become as common in Japan as in the United States, therefore, ultimately may depend on the extent to which Japanese firms find . . . that takeovers pay. . . . [M]ost writers have overestimated its uniformity and coherence and underestimated the extent to which individuals manipulate it strategically.”).

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there was a sudden change in Japanese culture. Moreover, once the globalization of the capital market is taken into account, ths argument seems obvisously flawed. The global investors in Korean stock market have no reason to be subject to Korean corporate culture.

One of the ways the U.S. law has developed to cure the lack of incentive

problem is “professional lawyers.” A derivative suit or a class action is typically brought by a plaintiff attorney, who is professionally specialized in such a lawsuit. It will be the attorney and not the nominal plaintiff who bears the litigation costs.90 It might be argued that, therefore, no matter how significant the litigation costs are, there will be several attorneys who are willing to take such an investment at each risk-return combination. To be sure, the higher litigation costs may reduce the number of lawyers who engage in this business, but if, for example, the market competition becomes more and more fierce, the effect of the litigation costs is likely to be offset by the pressure of market competition. In this case, therefore, the fundamental problem is not the litigation costs themselves, but the structure and competition in the legal profession market. Changes in the legal service market takes much longer, but this observation seems timely, since the legal service market in Korea is now under revolutionary changes; the number of lawyers has been dramatically increased in recent years and the opening of domestic legal service market to foreign law firms is imminent. In such more competitive market, a handful of lawyers are willing to organize a corporate litigation under the constraint of the exsisting cost structure.

In Korea, however, such theory is not a perfect fit. Suppose that all of the

litigation costs examined in Part II are negligible. Even in such case, a plaintiff shareholder in a derivative suit or a lead plaintiff in a class action in Korea must bear two significant legal uncertainties associated with litigation costs, even if the American-styled professional attorneys emerge.

The one relates to a “retainer” practice. It is quite common in Korean that

attorneys demand payment in the form of a “retainer” before the litigation begins. The retainer might be reimbursed by the defendant company if a plaintiff prevails in a derivative suit, and also the retainer paid in a class action might be credited if a class defeats the defendant. Assuming the plaintiff wins, it does not matter whether the payment is made in advance or not, but the plaintiff does not always win. The retainer is not refundable to a plaintiff in case of losing the suit. Thus, the retainer pratice may be viewed as an insurance policy granted to the attorneys, by which the risk associated with the investment is transferred from the attorney to the plaintiff. Such risk allocation may aggravate the moral hazard problem of the attorneys. As a result, shareholders or investors are discouraged to file a suit even though the attorneys are available, and the professional attorneys are also likely to engage in opportunistic behaviors.

90 See WILLIAM A. KLEIN & JOHN C. COFFEE, JR., BUSINESS ORGANIZATION AND

FINANCE: LEGAL AND ECONOMIC PRINCIPLES 196 (6th, 1996).

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The other risk associated with filing a suit is the British rule, as stated

above.91 Korea follows the British rule in allocating the litigation costs; a plaintiff losing the suit must pay the litigation costs—including attorney’s fees—reasonably incurred by the defendant. It should be kept in mind that the plaintiffs, not the plaintiff attorneys, are obliged to pay for the costs. Thus, the plaintiffs are not willing to file a suit, unless there is an agreement—whether it is confiential or not—that the attorneys will bear the litigation costs in full, including the costs incurred by the defendant according to the court order, and such agreement is effectively enforced by the court or at least by reputation mechanism in legal service market. Taken together, it is hard to perfectly eliminate the possibilities for shareholders to bear any costs.

In this context, recent researches on the derivative suits in Japan illustrate

several interesting results. According to professor West, a plaintiff usually loses in derivative suits.92 Therefore, the risk of losing a retainer fee is quite significant in Japan (Japan does not follow the British rule). Arguably, such expected costs on plaintiff-shareholders’ side might not exceed the expected value of a pro rata increase in the value of his or her shareholding. Why then do shareholders in Japan file so many derivative suits? Professor West reported several interesting changes in the Japanese legal service market. Most importantly, many attorneys reduced their retainers.93 Small retainers and large contingent fees becomes a standard of legal practice. In addition, to avoid large risk, attorneys select their cases carefully and avoid poor investment cases that the business judgment rule governs.94 To reduce the risk on plaintiff shareholders’ side and thus induce them to file a suit, several attorney’s made confidential agreement on fee-kickback; giving plaintiff a part of attorneys’ fee received from the companies.95 Taken together, it can be concluded that the attorney-driven market for derivative suits already emerged in Japan.

It should be noted that, in Japan, the possibilities for shareholders to bear

litigation costs has been eliminated by private arrangements with plaintiff attorneys, not by statutory reform. If such arrangements are invalidated for unfair or deceptive practices, probably it is the knell of derivative suits even in Japan.

91 See supra note 52 and accompanying text. 92 See West, supra note 30, at 357-358 (reporting that, from a database consisting of 73

derivative suits filed between 1993 and 1999, only 2 cases resulted in victory for plaintiffs and 4 cases are pending because of appeals by defendants).

93 Id. at 368-369 (a retainer of $30,000 for the damages claimed of $1.5 billion; under the Fee Rules, the retainer would be over $30 million).

94 Id. at 370. 95 Id. at 371 (mentioning that, although there is no specific prohibition of such practice,

the legal ground is “shaky”).

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The same “lawyer-driven” litigations will be witnessed in Korea, when the legal service market is sufficiently competitive.

What about the British rule in allocating the litigation costs? One way to

change this rule is to statutorily make an exception specifically in case of derivative suit and class acitons. Since such suits aim mainly at deterrence effect, rather than compensating the victims for damages, it may be convincingly argued that the cost allocation rule treat them as such. This is not the only way, however. Given that the British rule is effectively enforced, another way to implement this arrangement is, again, by contract. Since the entrepreneur lawyers must solicite a few investors—who are concerned about the British rule and thus are reluctant to get involved—to file a suit, they are likely to make a confidential agreement that they will pay the defendant’s attorney fees and other costs incurred if the suit is failed. As far as such an agreement should be continuously enforced by the court, the British rule will not prevent the lawyer-driven market from emerging.

3. Policy Issues of “Lawyer-Driven” Market

What is the cost of creating a lawyer-driven litigation system in Korea? Several scholars and politicians have concerned about the abuse of derivative suits and class actions, and argue that implementing such system is never an adequate strategy for a small economy like Korea. In other words, the idea of “regulation through litigation” seems to be highly costly in small emerging market. In particular, the U.S. experience tells that the litigations have almost nothing to do with regulating the agency costs of managers, and in fact, filing a suit itself may be regarded as another agency cost. These two results are closely connected. That is, since the litigations are very likely to end up with settlement which does not depend on the merit of the suits (agency cost), they have no impact on improving corporate governance system.

A. Collusive Settlement To begin with, many empirical and theoretical papers on derivative suits

and class actions report about the collusive settlement practice between defendant managers and plaintiff attorneys.96 The problem with this practice is not merely

96 See John C. Coffee, Jr., Understanding the Plaintiff’s Attorney: The Implications of

Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 COLUM. L. REV. 669, 698-700 (1986) (mentioning that the most interesting empirical observation is that “it results in very few litigated victories for plaintiffs”); Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs’ Attorney’s Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. CHI. L. REV. 1, 45 (1991) (“The attorney may also agree to an inappropriately low settlement on the merits in exchange for the defendant's implicit or explicit promise to allow the attorney to expend additional risk-free hours in order to build up a fee.”); Randall S. Thomas & Robert G. Hansen, Auctioning Class Action and Derivative Lawsuits: A Critical Analysis, 87 NW. U.L. REV. 423, 428 (1992) (citing Romano—“shareholder litigation is a weak, if not ineffective, instrument of corporate governance”); Susanna M. Kim, Conflicting Ideologies of Group

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that the lawyers file frivolous suits to threat innocent persons, but rather that the final settlement does not depend on the merit of the suits. If the managers are forced to settle, and thus the managers are sued regardless of their violation of fiduciary duty, then managers don’t have any reason for spending extra cost to taking care, for example.

In a setting of corporate litigations, both parties—plaintiff attorneys and

defendant managers—have strong incentives to settle. On attroney’s side, early settlement may reduce the downside risks by eliminating the possibility of losing the suit—assuming that such risks are borne by the attorneys. Morevoer, if the attorneys are paid only on the contingent fee basis, without consideration of hourly fee, their incentive for early settlement will be much stronger. On defendant managers’ side, on the other hand, directors and officers who are named as defendants may expect indemnification by the company or compensation by D&O insurance. Since such indemnification or insurance is hardly available to the defendants if they are found liable for a breach of their fiduciary duties by the court, the defendant directors and officers prefer the early settlement to obtaining final verdict, without clearly mentioning on the breach of duty issue. Both the attorneys and managers, in fact, are agents of the investors, but they collusively agree to harm the principal (might be called a “dual” agency cost).

Since the agency costs are generated on both sides, several solutions are

also suggested to both. Take the managerial incentive first. It may be suggested, for instance, that mandatory cap of settlement amount ratio may prevent managers from paying too much. D&O insurance companies may be involved by not compensating the entire agreed amount of settlement. In any event, punishing managers in case of settlement is the intutition behind these proposals, but the regulation has ex ante externality on the market for directors.97 In other words, any effort to regulate managerial incentive to settle may raise the reservation price for managers to be willing to work for the company, and as a result, the expenses that company incurs in order to attract talented managers must be raised. Since adjusting the liability of managers are closely related to the managerial incentive for a specific company, the agency cost problem generated on the managers’ side is unlikely to be resolved.

On the other hand, however, the regulation of plaintiff attorney’s

incentives is relatively feasible. It is worthwhile to note that one of the sources of the disappearance of deterrence effect is that attorneys are allowed to retain the Litigation: Who May Challenge Settlement in Class Actions and Derivative Suits? 66 TENN. L. REV. 81, 105-106 (1998) (mentioning that the strike suits “do little good for investors,” and that, from the corporation's perspective, “derivative suits carry the potential to do more harm than good”); James D. Cox, The Social Meaning of Shareholder Suits, 65 BROOK. L. REV. 3, 11-13 (1999) (arguing, in a different context, that “the public role of shareholder suits is muted, and indeed obfuscated”).

97 See Reinier Kraakman, Hyun Park & Steven Shavell, When Are Shareholder Suits in Shareholder Interests? 82 GEO. L.J. 1733, 1738 (1994).

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same monetary compensation when the disputes are finally settled. Thus, it may be proposed that the attorneys be deprived of their expected compensation package and thus be reimbursed only the costs that are actually incurred and proved, if the suit ends up with settlement. While the court should be generous in enforcing contractual arrangement of contingent fee arrangement if the suits are finally adjudicated, strict scrutiny for attorney fees should be made in case of settlement. In such case, the plaintiff attorneys will select the cases with higher probability of winning.

Still, however, there remain several sources for plaintiff attorneys to agree

on the settlement. In any event, the early settlement reduces uncertainties, and thus if the manager is willing to settle, the attorney does not have any reason to reject it. Then, the concept of “lawyer-driven” litigation system is still convincing to Korea? The anwer might be positive for several reasons. Perhaps, the culture or implicit norms in Korean legal profession, or even reputation mechanism may play a (limited) role. The Korean legal profession is still a small, closed society, and thus the reputation mechanism may be working for a while.

Furthermore, there are at least two procedural rules to prevent the

attorneys from filing a frivolous suit. Most notably, the discovery process is absent in Korean Civil Procedural Act. The plaintiff attorneys who do not know specifically about managerial wrongdoing or securitie fraud could not attempt to file a suit for the purpose obtaining its settlement value. Considering that the PSLRA of 1995 in the U.S. newly introduce an automatic stay of discovery process,98 its absence may play significant role in this context. Another procedural rule is the British rule, as stated above. From the above discussion, it was concluded that the effect of the British rule would be ultimately imposed on the plaintiff attorneys, through statutory reforms or private agreement. Therefore, such fee-shifting rule constrains the attorneys—not the plaintiff themselves—from bringing a frivolous suit.

Most importantly, however, the relevance of this debate on the Korean

corporate governance should not be exaggerated. In the long run, arguably, it might be systematically implemented for plaintiff attorneys to believe that filing a suit just for the settlement value is never profitable. The emphasis on the abusive practice, however, may harm the system in the short run. The over-heated debates on this issue caused several anti-abuse provisions to be incerted in the Securities Class Action Act in Korea, as described in Part II, but the pure effect was not to prevent abusive lawsuits, but just to paralyze the class action system itself. In fact, the Act should have not followed the PSLRA of 1995. For a time being, Korean legislators should have thought about how to make it fully-funtioning, rather than worry about over-functioning of the system.

98 See 33 Act § 27(b); 34 Act § 21D(b)(3)(B) (during the pendency of any motion to

dismiss).

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B. Social Benefit

Several studies have been made to measure social benefits of good corporate governance, in terms of abnormal stock price gain or increase in firm revenue or profit, but sometimes the empirical results turn out to be puzzling. For instance, the outside or independent directors do not improve firm performance.99 Also, contrary to the conventional understanding, the empirical tests show that class actions and derivative suits are very unlikely to result in the increase of shareholder value in terms of the stock price gain.100 Even the recent study using the Japanese derivative litigation data reports no significant shareholder gain associated with filing a derivative suit.101 Based on these researches, commentators might hastily conclude that encouraging investors or attorneys to sue directors and officers is unlikely to increase the national wealth. If the empirial researches are true, what are the social benefits from activating the derivative suits and class actions?

This issue should be more deeply debated, but this essay just adds two

comments. First of all, it was already examined that, in fact, filing a suit itself may be regarded as another agency cost. If the litigations are very likely to end up with settlement, they are very unlikely to have impact on improving corporate governance. Such agency costs are mixed with the social benefit, and thus the above researches may be interpreted as failing to isolate the pure benefit of the litigations. As discussed above, the litigations do not necessarily result in the agency costs, if the collusive settlement practice is properly regulated.

Most importantly, the empirical results concerning derivative suits and

class actions should be distinguished fromt those about the firm-level corporate governance tools. The independent directors, for instance, may be adopted by an individual firm, and the investors may take into account the adoption itself and the quality of independent directors in pricing the firm. In this case, therefore, the finding of insignifinant stock price gains associated with the election of independent directors implies that the independent directors have nothing to do with the firm performance. On the contrary, transforming the litigation system and legal profession to be more willing to file a suit will have impact on the whole companies in that jurisdiction, whether suits are actually brought or not. In other words, the social gain may be already incorporated in the stock price of each company, and thus bringing a lawsuit might not be associated with any abnormal returns. The social gain comes from the disciplinary or threatening nature of the

99 See supra note 9. 100 See Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the

Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 CORNELL L. REV. 261 (1986); Roberta Romano, The Shareholder Suit: Litigation Without Foundation? 7 J.L. ECON. & ORG. 55 (1991).

101 See CURTIS J. MILHAUPT & MARK D. WEST, ECONOMIC ORGANIZATIONS AND CORPORATE GOVERNANCE IN JAPAN 23-28 (2004).

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suits, and thus mere possibility, not actual bringing, of lawsuits accounts for the gain. Therefore, the magnitude of such gain depends on the extent to which the shareholders or investors—in a specific jurisdiction—are likely to bring lawsuits if managerial wrongdoings are revealed. Put differently, the actual filing a suit is not an event, or at best tells anything other than social benefit associated the disciplinary effect of corporate litigations. In conclusion, the social benefits from bringing a suit has not been yet cleared rejected.

CONCLUSION

Given the situation in which the ex ante monitoring or incentive

mechanisms such as independent directors, executive compensation, institutional shareholders, and voting system are inherently or practically defective, and the market for corporate control is hard to provide disciplinary function to managers, derivative suits and class actions may be the last and the most plausible candidate of institutional reform to improve the corporate governance. Korea has tried to activate the derivative suit system, and recently enacted the Securities Class Action Act. This essay compared the statutory differences of coporate litigations between Korea, Japan, and the U.S., and argued for activating the system.

To be sure, there must be several negative effects of filing a frivolous suit,

and Korean example—several anti-abuse provisions in the Securities Class Action in particular—may show how business persons and politicians make use of these concerns for destroying such disciplinary mechanism. The emphasis on the abusive practice, however, may not be appropriate in current Korea, where the agency costs of controlling shareholders are not yet adequately regulated and the private benefit of control is still large. The managers should be more subject to the threat of being sued, and it may create positive social benefits.