The consequences of limiting shareholder litigation: Evidence from exclusive forum provisions

In response to an explosion of shareholder litigation, many firms have adopted exclusive forum provisions which limit lawsuits to courts in a firm's state of incorporation. This paper examines the consequences of a required venue for shareholder litigation. Delaware-incorporated companies experience significant increases in firm value around exogenous events that confirmed the use of a specified forum. Reduced legal costs and the designation of the domicile court as the sole forum to hear shareholder claims contribute to the increase in firm value. Overall, these findings suggest that a required venue for shareholder litigation benefits firms by eliminating multi-jurisdictional lawsuits and reducing the threat of claims with little merit.     

Voluntary versus mandatory disclosure of liability insurance coverage limit

This article analyzes the disclosure of the liability insurance coverage limit and the impact of mandating disclosure of the coverage limit in a setting where voluntary disclosure of a firm’s cash flow information is subject to litigation risk and the firm has directors’ and officers’ (D&O) liability insurance. Disclosure of cash flow information is costly, but disclosure of the insurance coverage limit features no direct disclosure friction. We find that, when the litigation environment is weak, the usual unraveling argument applies, and the manager always voluntarily discloses the coverage limit in equilibrium. However, when the litigation environment is strong, either no coverage limit is disclosed or only sufficiently high coverage limits are disclosed in equilibrium. Further analysis shows that mandatory disclosure of the coverage limit increases the voluntary disclosure of cash flow information.     

Class-action privileges and contingent legal fees: Investor and lawyer incentives to litigate and the effect on audit quality

The Cohen Commission recognized the importance of litigation incentives and recommended that research based upon an economic approach be conducted into the effects that litigation incentives can have on the auditing profession. By extending Simon (1981), an economic analysis of an auditing environment is presented wherein audit firms issue reports, representative investors make decisions based upon audit reports, and lawyers (as well as representative investors) play an active role in determining whether or not to initiate litigation against audit firms. The influence that alternative litigation privileges (i.e., class-action privileges with contingent legal fees and no class-action privileges with fixed legal fees) have on representative investor and lawyer incentives to litigate and on the equilibrium characteristics of this audit market are analyzed.     

Market Imperfections as the Cause of Accounting Income Smoothing—The Case of Differential Capital Access

We show income smoothing results as a rational equilibrium behavior in a setting where the manager has superior foresight about the firm's prospects but faces inferior capital access relative to the owner. Under a legal structure that makes forecast-based compensation impractical and an accounting framework that requires reported income to be consistent, unbiased and cash-flow convergent, we show that the manager reports a composite of the underlying income and his foresight information. Moreover, the reported income will exhibit a lower inter-temporal variance than the underlying income. The extent of smoothing is shown to increase with the accuracy of foresight information.We argue that other market imperfections could also cause income smoothing if the manager is privately better informed about future prospects. As such, this paper supports the view that income smoothing is not always opportunistic but can be induced by the owner to satisfy his need to be informed about the future performance of the firm.     

Institutional monitoring and litigation risk: Evidence from employee disputes

In this article, we investigate how institutional investors help mitigate business‐related risks in a corporate environment. Using a large sample of employment disputes, litigations, and court cases, we find that institutional investors play a significant role in reducing employment litigation. We observe that firms with larger shares of institutional ownership have a lower incidence of employment lawsuits and that long‐term institutional investors are more effective at decreasing employee mistreatment. Our results suggest that institutional investors can improve the employee work environment and help mitigate future employee litigation. The improvement in employee work conditions has been shown to increase a firm's value through increased employee output, reduced litigation, and direct and indirect costs. Our results shed light on the effectiveness of institutional monitoring on a firm's litigation risk.     

Impact of Segment‐level Natural Resource Operational Risk Reporting on Earnings Predictions

Non‐financial reports alert investors to operational risks associated with issues such as insufficient access to natural resource inputs and related costly interruptions to production, while segment‐level reports alert investors to operational risk distribution across a firm. An important issue, to date unexplored, is how segment‐level non‐financial reporting has an impact on earnings predictions. We report the results of an experiment used to examine how mining company segment‐level water reports affect investors' earnings predictions, where water reports indicate whether the firm and its segments will have access to sufficient water to meet production needs. We find that investors do not change their earnings predictions when firm and segment‐level reports indicate low water risk but they do revise down their earnings predictions when firm and segment‐level water reports indicate high water risk. This is consistent with investors responding to the additional information provided in segment‐level reports confirming that water risk is high across the firm. Regardless of whether firm‐level water reports indicate high or low water risk, when segment‐level reports indicate that one segment is low water risk and another is high water risk, investors revise down their earnings predictions. This is consistent with investors recognizing that natural resource operational risk concentration in one segment can affect earnings more than evenly‐distributed risk. Overall, our findings suggest that belief‐adjustment theory explains how investors react to prospective operational risk information contained in segment‐level water reports according to the similarity of the segment‐level risks, and that this information is factored into earnings predictions.     

Information disclosure and liquidity crisis

We analyze a model in which a firm’s manager privately learns about the expected return on the firm’s project and strategically discloses it to investors (i.e., discretionary disclosure). Based on the manager’s disclosure, investors decide whether to withdraw their investments from the firm. Our analysis indicates that investors’ optimistic prior beliefs in the firm reduce the possibility of their withdrawals and the manager’s incentive of discretionary disclosure, whereas pessimistic beliefs increase them. We further examine the effects of a commitment to reporting of bad news, namely, the conservative disclosure rule. This rule always suppresses the manager’s incentive of discretionary disclosure; however, it increases (reduces) investors’ withdrawals when they are optimistic (pessimistic) about the firm’s project.     

Outside Directors,Litigation Environment,and Management Earnings Forecasts

This study examines whether outside directors factor in litigation costs for the firm while monitoring optimal disclosure policy. It investigates the association of management earnings forecast disclosure and the proportion of outside directors across two regimes with unequal litigation costs, the United States and Canada. I find that the positive association between forecast frequency/ precision and the proportion of outside directors is stronger in Canada. This suggests that outside directors are more likely to encourage disclosure in less litigious Canada. I also find that firm‐level governance mechanisms such as outside directors and country‐level litigation environment act as governance substitutes in determining unbiased forecasts. Specifically, the negative association between forecast bias and the proportion of outside directors is stronger in Canada. I also revisit the effect of legal regime on forecast disclosure in a non‐U.S. context. Recent legislation has increased the likelihood of class‐action lawsuits in Canada. The passage of these laws has decreased the precision in forecasts by Canadian firms.     

Judge political affiliation and impacts of corporate environmental litigation

This study examines the role of judges' political affiliation in determining the outcomes of environmental lawsuits filed against public corporations and their economic impacts on the defendant firms. Drawing on legal theories of judicial decision making, individual judges are expected to play an important role in influencing lawsuit outcomes and consequently the sued firms' shareholder wealth. This study employs a hand-collected sample of environmental lawsuits filed in the U.S. Federal District Courts against public firms during 2000–2015, utilizing the random assignment of judges to lawsuits to combat endogeneity concerns. The empirical evidence shows that lawsuits with Republican-appointed judges are approximately 12% less likely to succeed in reaching a settlement compared with those adjudicated by Democratic-appointed judges, holding constant other lawsuit-, judge-, and firm-specific factors. Further, investors of defendant firms react more favorably to the outcome of a lawsuit adjudicated by a Republican-appointed judge compared with a Democratic appointee: the difference of 0.6% of market value during the three-day period surrounding the lawsuit conclusion represents a substantial saving of shareholder wealth. These significant differences are not attributable to alternative explanations, such as other judge idiosyncrasies or firm characteristics, and remain robust to a series of additional analyses. These empirical findings offer new insights into the significant impacts of judge political affiliation on corporate environmental litigation and provide novel evidence on the magnitude of their economic consequences.     

Signalling by direct disclosure under asymmetric information

In this paper, an informational asymmetry exists between investors and the issuer of an initial public offering about the value of the security. To avoid market failure, a solution is proposed in which the issuer makes a disclosure about firm value that is verified by an investment banker. The investment banker enters into a contingent contract with investors which imposes a penalty if the ex post observable cash flow indicates fraudulent disclosure. A bivariate signalling model is formulated and solved, and testable implications are derived from comparative statics analysis.     

The curious case of Canadian corporate emissions valuation

This study examines the relevance to investors of the greenhouse gas (GHG) emissions of publicly-traded Canadian firms over 2006–2018. Based on two independent datasets, we document that firm value varies positively in the level of emissions. This result suggests that the Canadian setting differs from those studied previously, notably because of low climate litigation risk and national and subnational expenditure policies to offset climate impacts on the economy. While national and subnational expenditures to mitigate emissions affect firms' on-balance-sheet costs and profits, investors price the future payoffs to these expenditures into firm value. Supporting this view, we find that the positive relation between emissions and firm value in Canada is amplified for high GHG-intensity firms (mainly energy firms in Alberta), whose future payoffs to environmental policies and spending exceed those of low GHG-intensity firms. Our results are consistent with investors’ recognition of the benefits to firm value of national and subnational policies to decarbonize the Canadian economy.     

Institutional monitoring through shareholder litigation

This paper investigates the effectiveness of using securities class action lawsuits in monitoring defendant firms by institutional lead plaintiffs from two aspects: (1) immediate litigation outcomes, including the probability of surviving the motion to dismiss and the settlement amount, and (2) subsequent governance improvement such as changes in board independence. Using a large sample of securities lawsuits from 1996 to 2005, we show that institutional investors are more likely to serve as the lead plaintiff for lawsuits with certain characteristics. After controlling for these determinants of having an institutional lead plaintiff, we show that securities class actions with institutional owners as lead plaintiffs are less likely to be dismissed and have larger monetary settlements than securities class actions with individual lead plaintiffs. This effect exists for various types of institutions including public pension funds. We also find that, after the lawsuit filings, defendant firms with institutional lead plaintiffs experience greater improvement in their board independence than defendant firms with individual lead plaintiffs. Our study suggests that securities litigation is an effective disciplining tool for institutional owners.     

Earnings management, lawsuits, and stock-for-stock acquirers’ market performance

There is a positive association between stock-for-stock acquirers’ pre-merger abnormal accruals and post-merger announcement lawsuits. The market only partially anticipates the effects of post-merger announcement lawsuits at the merger announcement and the post-merger announcement long-term market underperformance is largely limited to litigated acquisitions. Overall, the evidence suggests that it is important that investors not only undo the direct stock price effects of earnings management but also factor the contingent legal costs associated with earnings management.     

媒体新闻报道的声誉溢出效应

本文聚焦于公司违规曝光这一特定事件,使用三重差分的计量分析方法,探讨了媒体的事前新闻报道是否会影响其在投资者群体中的声誉,即是否存在声誉溢出效应。结果表明媒体对违规公司的事前新闻报道越正面(负面),其日后针对非涉案公司发布的新闻报道的市场反应就越弱(强),即存在双向声誉溢出效应。然而该效应存在不对称性,表现为负面报道带来的正向溢出效应明显强于正面报道带来的负向溢出效应。进一步研究发现,声誉溢出效应取决于投资者对于媒体声誉的主观感知以及对于违规事件的信息解读能力。当媒体的既有声誉水平较低、违规案件较为严重,或非违规公司机构投资者比例较高时,媒体的声誉溢出效应更加明显。本文论证了媒体客观公正性对于声誉积累的重要性,为媒体是否应当以及如何维护在投资者群体中的声誉形象提供了经验证据。本文对投资者如何判断和使用媒体发布的信息,进而做出正确投资决策也具有重要意义。     

Accountability of independent directors: Evidence from firms subject to securities litigation

We examine which independent directors are held accountable when investors sue firms for financial and disclosure-related fraud. Investors can name independent directors as defendants in lawsuits, and they can vote against their reelection to express displeasure over the directors’ ineffectiveness at monitoring managers. In a sample of securities class action lawsuits from 1996 to 2010, about 11% of independent directors are named as defendants. The likelihood of being named is greater for audit committee members and directors who sell stock during the class period. Named directors receive more negative recommendations from Institutional Shareholder Services, a proxy advisory firm, and significantly more negative votes from shareholders than directors in a benchmark sample. They are also more likely than other independent directors to leave sued firms. Overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.     

Misstatement Direction, Litigation Risk, and Planned Audit Investment

This study reports the results of an experiment showing that auditor assessments of litigation risk and planned audit investments are higher when potential errors overstate financial performance than when those errors understate performance. This result is much stronger in the presence of high levels of litigation risk in the client's industry. These results suggest that in industries where litigation risk is high audited financial statements may contain more unintentional material understatement errors than overstatement errors. Thus, litigation risk—through its effect on auditors—may encourage financial statements that understate firm performance     

Litigation exposure,capital structure and shareholder value: the case of Brooke Group

We examine value creation and destruction in the tobacco industry due to the radical litigation strategy of Brooke Group CEO Bennett LeBow. Brooke Group had tiny market share, low margins, high leverage and highly concentrated management ownership. Beginning in 1996, the firm reached settlements in lawsuits brought against all cigarette companies by class action plaintiffs and US state governments. Brooke Group's actions, which included promises to cooperate in litigation against its rivals, spurred other companies to reach settlements on less favorable terms. These events led to massive wealth destruction within the industry but impressive returns for shareholders of Brooke Group.     

The price of power: Valuing the controlling position of owner–managers in French IPO firms

Going public often creates an agency conflict between the owner–manager and minority shareholders. This problem is especially severe in countries with poor legal investor protection, such as France. We examine the controlling position of owner–managers in French initial public offering (IPO) firms. We find that investors anticipate the increased agency conflict associated with a lock on control and lower firm value when the owner–manager is more powerful. Shareholder agreements in which the owner–manager agrees to share control with other pre-IPO owners enhance firm value. We also report that higher cash flow ownership by the owner–manager is positively related to firm value when he is not in full control. Finally, we document that the large (non-pecuniary) private benefits of control in France may motivate owner–managers to retain control after the IPO.     

Litigation risk,financial reporting and auditing: A survey of the literature

This paper surveys the literature on the determinants and consequences of securities class action lawsuits against firms and auditors from a financial reporting quality perspective. The survey is motivated by the important role that law plays in protecting stakeholders' interests against managerial misdeed. Litigation is, thus, an important topic and numerous studies investigate the determinants and consequences of firm and auditor lawsuits. The underlying premise of these studies is built on the notion that large financial and reputational penalties associated with successful securities class actions can discipline management and deter them from future wrongdoing. The survey documents that poor quality financial reporting as evidenced in earnings restatements has been the primary antecedent for class action lawsuits against the firm and auditors. Lawsuits against auditors affect audit fees, audit planning decisions and client portfolio adjustment decisions. Although significant progress has been made in terms of further understanding the causes and consequences of litigation against auditors, major challenges remain in the area of proper measurement of litigation risk.     

Federal Judge Ideology: A New Measure of Ex Ante Litigation Risk

Drawing on the political theory of judicial decision making, our paper proposes a new and parsimonious ex ante litigation risk measure: federal judge ideology. We find that judge ideology complements existing measures of litigation risk based on industry membership and firm characteristics. Firms in liberal circuits (the third quartile in ideology) are 33.5% more likely to be sued in securities class action lawsuits than those in conservative circuits (the first quartile in ideology). This result is stronger after the U.S. Supreme Court's ruling in the Tellabs case. We next show that the effect of judge ideology on litigation risk is greater for firms with more sophisticated shareholders and with higher expected litigation costs. Furthermore, judicial appointments affect litigation risk and the value of firms in the circuit, highlighting the economic consequences of political appointments of judges. Finally, using our new measure, we document that litigation risk deters managers from providing long‐term earnings guidance, a result that existing measures of litigation risk cannot show.