For decades, the debate over arbitration agreements and class action waivers in consumer financial services contracts has largely played out in courtrooms, before regulators and Congress, and in academic journals. Advocates and critics have debated issues ranging from consumer access to justice and deterrence to litigation costs and whether the benefits of arbitration are ultimately passed along to consumers.

A new study approaches the issue from a very different perspective: What does the stock market tell us about the economic value of class action waivers to financial services companies?

In the episode of the Consumer Finance Monitor podcast released today, the host of the show, Alan Kaplinsky (founder, former leader for 25 years, and now Senior Counsel of our Consumer Financial  Services Group) spoke with James Fallows Tierney, Associate Dean for Academic Affairs and Associate Professor of Law at Chicago-Kent College of Law, about his working paper, “The Value of Class Action Waivers: Evidence from Invalidation of the CFPB Arbitration Rule.” Professor Tierney’s research focuses on the intersection of law, financial markets and consumer finance. 

His study uses financial-market data to examine how investors reacted to developments affecting the enforceability of consumer arbitration agreements containing class action waivers.

An Eight-Year Project

Professor Tierney explained that the project grew out of the regulatory debate surrounding the CFPB’s 2017 arbitration rule. During that debate, there was considerable disagreement about what happened to the savings generated when class action waivers prevent companies from facing class litigation.

One side argued that competition would force companies to pass those savings along to consumers through lower prices or better terms. Critics questioned that assumption and argued that companies could retain some of the savings.

Professor Tierney saw an opportunity to examine one part of that debate empirically. If investors believed that enforceable class action waivers reduced a company’s future litigation exposure and costs, changes in the likelihood that those waivers would remain enforceable should be reflected in the company’s stock price.

His study therefore asks a relatively narrow question: Do investors view the enforceability of class action waivers as having economic value to affected companies?

Letting the Market “Speak”

The working paper uses an “event study,” a technique commonly used in financial economics to measure how a particular event affects stock prices.

Professor Tierney identified 11 significant public events during the CFPB arbitration rulemaking and subsequent Congressional Review Act repeal process. He then compared publicly traded financial companies whose businesses were subject to the CFPB’s rule with comparable financial companies that were not subject to it.

The methodology attempts to isolate the portion of a stock’s movement attributable to the arbitration-related event rather than broader movements in the stock market or financial-services sector.

As Professor Tierney explained during the podcast, this approach does not answer every question surrounding arbitration. It does, however, provide a way of testing whether investors viewed the enforceability of class action waivers as economically significant.

What Did the Study Find?

The headline finding is striking.

According to Professor Tierney, companies exposed to the CFPB’s arbitration rule experienced stock-price movements in the predicted direction of approximately 0.71% per event, relative to comparable companies, and the result was statistically significant. The finding also remained when he changed aspects of the analysis.

The largest reaction occurred after the Senate approved the Congressional Review Act resolution repealing the CFPB’s arbitration rule. The Senate vote occurred after the markets had closed and required Vice President Pence to break a 50-50 tie. The following trading period produced an approximately 2% difference between the affected and comparison companies, the largest reaction among the events examined.

Professor Tierney believes the magnitude of that reaction may have reflected the uncertainty surrounding the repeal. Unlike many of the earlier events in the rulemaking process, the outcome of the Congressional Review Act process was not a foregone conclusion.

The broader finding, in his view, is that investors treated the enforceability of class action waivers as an attribute relevant to firm value rather than simply as contractual boilerplate.

What About Consumers?

Importantly, the study does not establish that arbitration is good or bad for consumers, nor does it attempt to resolve the broader policy debate.

Professor Tierney emphasized that his study measures investor expectations concerning the future economic consequences of arbitration protection. It does not measure actual litigation costs, consumer prices, wages or the distribution of savings between companies.

The findings are consistent with the proposition that companies retain at least some of the economic benefits associated with reduced exposure to class action litigation. If investors expected all of those savings to be passed through to consumers through competition, changes in the enforceability of class action waivers presumably would have less effect on the value investors assign to affected companies.

But, as Professor Tierney stressed, the study does not tell us precisely who ultimately receives those benefits.

Important Limitations

Professor Tierney was candid about several limitations of the research.

Most significantly, an event study can capture other news occurring at approximately the same time as an arbitration-related event. He has not yet completed a detailed audit of each of the 11 events against a comprehensive news database to determine whether company-specific developments or other information could have affected the results.

The study also measures investor expectations rather than actual litigation costs. A future study could potentially examine whether the adoption or invalidation of arbitration provisions actually affects litigation expenses, the number of lawsuits, consumer prices or other economic measures.

And, although the study attempts to distinguish arbitration-specific developments from broader financial-sector movements, Professor Tierney acknowledged that further research could examine other CFPB-related events to determine whether investors reacted differently to companies affected by arbitration policy and those that were not.

A Different Way of Looking at an Old Debate

What we found particularly interesting about Professor Tierney’s study is not that it purports to resolve the long-running debate over arbitration. It doesn’t.

Instead, it provides an empirical perspective that has largely been missing from that debate.

The CFPB itself previously studied consumer arbitration and estimated that eliminating class action waivers would result in billions of dollars in additional costs to consumer financial services providers over a five-year period. Professor Tierney’s research approaches the question from the other direction: rather than asking what companies might spend, he examines how investors actually reacted when the legal environment surrounding class action waivers changed.

The debate over arbitration will undoubtedly continue. But Professor Tierney’s work demonstrates that financial-market data can provide another lens through which to examine the real-world economic consequences of legal and regulatory rules.

Listen to the full Consumer Finance Monitor podcast with Professor James Fallows Tierney to hear our discussion of his methodology, the 11 events examined in the study, the stock-market reaction to Congress’s repeal of the CFPB arbitration rule, the study’s limitations, and where this research could go next.