August 11, 2009
Economics Department
Coupon Madness
Over at Simple Justice, Scott Greenfield has taken time off from bashing marketers to bash coupon settlements. That's when some lawyers initiate a lawsuit against a corporation on behalf of a large number of people, and then settled for a payment that allows the corporation to send out some sort of redeemable coupon instead of cash.
In this case, it's the Ford Explorer rollover settlement, as summarized by the WSJ Law Blog:
The AP has a story out Monday taking a sort of retrospective snapshot on the Ford Explorer rollover class-action litigation. As part of a settlement reached last year, the nearly 1 million class members covered by the lawsuit each received the opportunity to claim a coupon worth either $300 or $500 toward the purchase of a new Ford vehicle. As of June 2009, according to the piece, only 75 people had used the coupons, at a cost to Ford of $37,500. The plaintiffs' lawyers, meanwhile, took home $25 million in fees and expenses.
Coupon settlements are a giant conflict of interest between the class-action lawyers and the people in the class.
To see why, consider a literary agent who's charging 15% to sell a book for an author. Suppose that by putting in an extra 100 hours of work, he could get the author an extra $100,000 on the book deal. That would earn him an extra $15,000 in commission, which works out to $150 an hour. If the agent values his own time at more than $150 an hour---presumably because he could earn that much working on another author's book---then he has no incentive to keep working. It's to his financial benefit to take the quick deal. But then his client is out the other $85,000.
This conflict is unavoidable whenever someone earns a fraction of the value of their work. It's why executive headhunters always push job-seekers to take the first offer, it's why real estate agents don't get sellers the price they want, and it's why factory workers don't work as hard as the factory's owners wish they would. It's also why lawyers working on a contingency fee are likely to settle for a smaller amount than their clients would prefer.
Coupon settlements are an especially egegious form of this problem for several reasons.
First, clients don't get to pick their lawyers, a judge does. I'm a little vague on the process, but I don't think the judge puts a high priority on the lawyers' proposed fee structure.
Second, clients have no bargaining power. Even though they usually have the ability to opt out of the class, there's nowhere else to go. By the nature of a class action, a mass lawsuit is the only effective remedy. Clients have almost no leverage to force the lawyers into a more equitable agreement. (As Scott Greenfield points out, there are people working to change that.)
Third, return business is not an issue. Some of the other examples I've given---such as literary agents and contingency-fee lawyers---hope to gain return business from the client and will therefore work harder on his or her behalf. Essentially, their true commission for doing well consists not only of the immediate commission, but the chance to earn future commissions. This makes them work harder for their clients. Class action lawyers have no such motivation.
The biggest problem with coupon settlements, however, is the difficulty in evaluating the value of the coupons at the time of the settlement.
It's easy to evaluate the coupons retrospectively, once we have information about their redemption rate. In the Ford Explorer case, members of the class have so far redeemed coupons worth $37,500. I think that's the cost of one tricked-out Ford Explorer. It's hardly a settlement for the lawyers to be proud of. It's probably not a settlement worth $25 million dollars either.
Even if that grows to $100,000 before all is said and done, the math is still pretty dismal: The lawyers won $25,100,000 in the lawsuit and kept $25,000,000 of it for themselves. That's a 99.6% fee.
The math probably looked a lot different at the time of the settlement. One million class members receiving coupons worth $300 to $500 each could add up to half a billion dollars, making the $25 million legal fee seem reasonable.
I suppose there are some who would argue that it's not the lawyers' fault if the class members failed to take advantage of the $500 million award. The thing is, the value of the coupons depends on what you can get for them, and so far that's just $37,500. I think an economist would regard this as the final, revealed, true value of the coupons.
Since lawyers are supposed to act in the best interests of their clients---the class members---they should also regard the revealed value to the clients as the only value that counts. I can't see any other intellectually honest way to look at it.
It would be naive to think that no one saw this coming. I think the key is to look at who had the most information about the value of the coupons at the time of the settlement. In order, they are:
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The class members. As the people who would receive the coupons and use them (or not), they knew more about their value than anyone, due to the fact that their behavior determines the value.
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Ford Motors. I'm sure Ford knows its customers and understands how they behave. The automaker may make mistakes and get fooled by its customers, but it still knows them better than anyone except the customers themselves.
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The lawyers. They spent a lot of time on this case and must have had a pretty good idea what would happen.
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The judge. He pretty much has to take the lawyers' word for what's good for their clients.
Since the class members are kept from direct involvement (with a few exceptions), the most knowledgable parties are the defendant, Ford Motors, followed by the lawyers. Naturally, they got the sweetest deal. Morally (although probably not legally), the lawyers essentially colluded with Ford to betray their clients.
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