Shareholder litigation rights and corporate payout policy: Evidence from universal demand laws

This study exploits the staggered adoption of universal demand (UD) laws, which place significant obstacles to derivative lawsuits and thus, undermine shareholders’ rights by 23 states in the United States (U.S.) from 1989 to 2005 as a quasi-natural experiment to examine the effects of shareholder litigation rights on corporate payout policy. Weakened litigation rights for shareholders materially increase firms’ payout ratios. The effect is more pronounced for firms exposed to higher shareholder litigation risk ex-ante, firms with higher institutional holdings, and ones financially unconstrained. Overall, the findings are consistent with lower shareholder litigation threats motivating firms to increase dividend payouts.     

Shareholder Litigation and Corporate Disclosure: Evidence from Derivative Lawsuits

Using the staggered adoption of universal demand (UD) laws in the United States, we study the effect of shareholder litigation risk on corporate disclosure. We find that disclosure significantly increases after UD laws make it more difficult to file derivative lawsuits. Specifically, firms issue more earnings forecasts and voluntary 8‐K filings, and increase the length of management discussion and analysis (MD&A) in their 10‐K filings. We further assess the direct and indirect channels through which UD laws affect firms' disclosure policies. We find that the effect of UD laws on corporate disclosure is driven by firms facing relatively higher ex ante derivative litigation risk and higher operating uncertainty, as well as firms for which shareholder litigation is a more important mechanism to discipline managers.     

CAPITAL STRUCTURE,SHAREHOLDER RIGHTS,AND CORPORATE GOVERNANCE

We show how capital structure is influenced by the strength of shareholder rights. Our empirical evidence shows an inverse relation between leverage and shareholder rights, suggesting that firms adopt higher debt ratios where shareholder rights are more restricted. This is consistent with agency theory, which predicts that leverage helps alleviate agency problems. This negative relation, however, is not found in regulated firms (i.e., utilities). We contend that this is because regulation already helps alleviate agency conflicts and, hence, mitigates the role of leverage in controlling agency costs.     

The Effect of Managerial Litigation Risk on Earnings Warnings: Evidence from a Natural Experiment

We examine the causal effect of managerial litigation risk on managers’ disclosure of earnings warnings in the face of large earnings shortfalls. Exploring the staggered adoption of universal demand (UD) laws as an exogenous decrease in litigation risk, we find that the adoption leads to a decrease in managers’ issuance of earnings warnings, especially among firms facing a higher litigation risk prior to the adoption. In contrast, we find no change in managers’ tendency to alert investors of impending large positive earnings surprises. Collectively, our results provide causal evidence that higher litigation risk incentivizes managers to issue more earnings warnings. Our results differ from Bourveau et al.’s finding of an increase in the frequency of management earnings forecasts after the adoption of UD laws. We reconcile our findings with theirs by demonstrating that the effect of adopting UD laws on management earnings forecasts depends critically on forecast horizon: The adoption increases long-horizon forecasts, but decreases short-horizon forecasts.     

Securities class actions and conditional conservatism: Evidence from two legal events

We use two US court rulings as exogenous shocks to firms' litigation environment and examine the changes in conservative financial reporting following these court decisions. The Silicon Graphics ruling in 1999 imposed a heightened pleading standard and discouraged the filing of shareholder lawsuits against firms with headquarters in the Ninth Circuit. The Tellabs ruling in 2007, however, effectively reversed the Silicon Graphics ruling and made it easier to file securities litigation against Ninth Circuit firms. We predict and find that the reduced litigation risk following the Silicon Graphics ruling discourages conservative reporting for Ninth Circuit firms. By contrast, the elevated threat of shareholder lawsuits following the Tellabs ruling encourages conservative reporting for Ninth Circuit firms relative to non-Ninth Circuit firms. The disciplining effect of the threat of shareholder lawsuits on conservatism is stronger for firms facing higher ex ante litigation risk. The litigation-risk-induced increase (decrease) in reporting conservatism leads to higher (lower) firm valuations.     

When do peers matter?: A cross-country perspective

We assess the importance of industry peers for a firm's own decision making strategy, using a rich sample of data covering 47 countries and 87 different industries between 1990 and 2011. Following the instrumental variable approach suggested by Leary and Roberts (2014), we find that, similar to U.S. firms, foreign firms do follow their peers when they make financial policy decisions. A standard deviation increase in peer firms' average leverage leads to about 5 percentage point increase in a firm's own leverage. We also find evidence that firms are more likely to follow their peers when investor protection laws including information disclosure and minority shareholder protection are weak, when creditor rights laws are strong, and when equity markets are more developed, suggesting that peers matter the most when firms have the greatest need to learn and to demonstrate their quality. These results hold even when we perform the analysis on a matched sample of firms.     

Shareholder litigation rights and stock price crash risk

We study the impact of shareholder-initiated litigation risk on a firm's stock price crash risk. Our empirical analysis takes advantage of the staggered adoption of universal demand laws, which led to an exogenous decline in derivative litigation risk. We find that a decline in the threat of derivative litigation reduces crash risk and that information hoarding associated with earnings management is a channel through which litigation risk affects crash risk. The relationship is also moderated by how exposed firms are to the other primary form of shareholder litigation, namely securities class-action lawsuits.     

Information asymmetry,leverage and firm value: Do crisis and growth matter?

Drawing on pecking order and agency cost theories, we assess the extent to which information asymmetry is an important determinant of firm value and the extent to which this relationship is conditional on the leverage level of firms. We also assess the impact of information asymmetry on firm value during the pre and post 2007/09 financial crisis period and for high and low growth opportunity firms. Using a large sample of UK firms, our empirical findings suggest that information asymmetry adversely impacts firm value, and that this effect decreases with firm's leverage. We also find that leverage has a negative effect on firm value, and that the marginal effect of leverage is lower for information asymmetric firms. Further, we find that the relation between information asymmetry and firm value is more pronounced in the post-crisis period than the pre-crisis period. Finally, we show that the impact of information asymmetry on firm value is higher (lower) for firms with high (low) growth opportunities.     

Director–Liability–Reduction Laws and Conditional Conservatism

We study nonofficer directors’ influence on the accounting conservatism of U.S. public firms. Between 1986 and 2002, all 50 U.S. states enacted laws that limited nonofficer directors’ litigation risk but often left officer directors’ litigation risk unchanged. We find that conditional conservatism decreased after the staggered enactments of the laws, which we attribute to less nonofficer director monitoring of financial reporting in affected firms. Conservatism fell less when shareholder or debtholder power was high, consistent with major stakeholders moderating the influence of nonofficer directors. We verify that our results stem from reductions in the asymmetric timeliness of accruals and, specifically, its current assets components. We also show that affected firms switched away from Big N auditors more often, which reduced these firms’ commitment to conservative financial reports.     

Firing Costs and Capital Structure Decisions

I exploit the adoption of state‐level labor protection laws as an exogenous increase in employee firing costs to examine how the costs associated with discharging workers affect capital structure decisions. I find that firms reduce debt ratios following the adoption of these laws, with this result stronger for firms that experience larger increases in firing costs. I also document that, following the adoption of these laws, a firm's degree of operating leverage rises, earnings variability increases, and employment becomes more rigid. Overall, these results are consistent with higher firing costs crowding out financial leverage via increasing financial distress costs.     

Financial industry lobbying and shareholder litigation outcomes: implications for managers and regulators

We examine the relationship between financial firm corporate lobbying, shareholder-based litigation outcomes, and firm value. We show that political lobbying lowers federal class action securities litigation likelihood for public financial institutions. Secondly, lobbying firms experience a higher likelihood of having litigation dismissed, and the average settlement amount is significantly lower for lobbying institutions. In addition, shortly after a litigation announcement, lobbying firms experience significantly higher cumulative abnormal returns (CARs), compared to non-lobbying firms. Finally, we show that lobbying firms have higher long-run buy-and-hold abnormal stock returns (BHARs) following lobbying activities. Our results link financial institution lobbying activity with improved legal outcomes and relatively higher firm value. While lobbying improves financial firm value, our results also imply that lobbying creates a disadvantage for non-lobbying firms within the industry. Our results provide insights, not only to corporate managers, but to regulators and policymakers interested in the impact of lobbying on the efficacy and objectivity of regulation and enforcement in the financial services industry.     

Do Firms Decouple Corporate Governance Policy and Practice?

We test whether Thai listed firms with higher levels of good governance policy adoption are less likely to violate listing rules and laws designed to protect shareholders. Our results suggest that firms on average implement, substantively as opposed to symbolically, recommended governance policies, as violations occur less frequently among firms with higher governance policy adoption scores. However, we also find evidence of symbolic governance among a small group of ‘talk‐only’ firms that issue statements about governance while lagging in the adoption of policies related to shareholder rights and the board of directors.     

Financial reporting quality and dividend policy: New evidence from an international level

This study examines the link between financial reporting quality and dividend payout across 76 countries. We find that financial reporting quality increases dividend payout after controlling for firm and country specifics. We also investigate different channels that moderate the relation between financial reporting quality and dividend payout. We find that the positive association between high-quality financial reporting and dividend payout is more pronounced when firms have free cash flow problems, face severe information asymmetry, and are located in countries with weaker minority shareholder protection rights. Interestingly, we find evidence that high reporting quality enhances firms' payment of dividend even when these firms already overpaying their shareholders. However, the relation becomes weaker when firms overpass the optimal level of dividend payout. The findings remain consistent after several robustness checks, thus highlighting the effectiveness of more transparent disclosure of financial information in reducing information asymmetry related to firms' internal agency costs and their relationships with external parties.     

Large shareholders, board independence, and minority shareholder rights: Evidence from Europe

We examine the relation between minority shareholder protection laws, ownership concentration, and board independence. Minority shareholder rights is a country-level governance variable. Ownership structure and board composition represent firm-level governance variables. Prior research hypothesizes and documents a negative relation between countries' minority shareholder rights quality and firms' ownership concentration. We introduce the hypothesis that shareholder protection rights and firms' board independence are positively related. When a country's minority shareholder rights are strong, then minority shareholders should have the legal power to affect board composition. Using a sample of large firms from 14 European countries, we test both hypotheses and find that countries with stronger shareholder protection rights have firms with lower ownership concentrations and with more independent directors, consistent with both hypotheses. We also find evidence that ownership concentration and board independence are negatively related.     

Do shareholders really matter for firm performance? Evidence from the ownership characteristics of Italian listed companies

This paper studies the impact of the features of the shareholder base on the performance of a large sample of Italian listed firms between 2007 and 2019, both within and across firms. We expand the empirical evidence on the relation between shareholder type and different dimensions of firm performance by dividing shareholders into six categories, and further differentiating between domestic and foreign investors. We provide extensive evidence on the relation between firm performance and different types of shareholders, showing how diverse performance metrics are correlated with the voting rights of specific types of shareholders. Consistent with previous studies, the picture that emerges from our analysis shows that the ownership structure of Italian listed companies is characterized by a high degree of concentration. In this context, we find that ownership concentration or the presence of a controlling shareholder is in general associated with better performance. Moreover, a positive relation exists between diverse firm performance metrics and the voting rights of family shareholders, founders and foreign investors, while government ownership is detrimental in the short-term.     

International evidence on the non-linear impact of leverage on corporate cash holdings

This paper investigates cash holding behaviour of firms from France, Germany, Japan, the UK and the US using data for 4069 companies over the period 1996–2000. Our focus is particularly on the relation between cash holdings and leverage. We argue that the impact of leverage on cash balances of firms is likely to be non-monotonic. To the extent that leverage of firms acts as a proxy for their ability to issue debt one would expect a negative (substitution effect) relation between leverage and cash holdings. However, as leverage increases firms are likely to accumulate larger cash reserves to minimise the risk of financial distress and costly bankruptcy. Thus, one would expect a positive (precautionary effect) relationship between cash holdings and leverage at high levels of leverage. Our findings provide strong and robust support for a significant non-linear relation between cash holdings and leverage. Additionally, our results show that the impact of leverage on cash holdings partly depends on country-specific characteristics such as the degree of creditor protection, shareholder protection, and ownership concentration.     

Are Multiple Directorships Beneficial in East Asia?

We posit that the benefits and costs of multiple directorships are conditional on firm characteristics. We find firm valuation is positively associated with multiple directorships in (i) firms with high advising needs and (ii) firms with high external financing needs. These beneficial effects of multiple directorships are generally stronger in countries with weak shareholder rights and in firms that are widely held. However, when controlling shareholder hold high voting‐rights to cash‐flow rights, multiple directorships reduce firm valuation, especially in countries with weak shareholder rights and in closely held firms. As multiple directorships increases, cash holdings (capital expenditures) contribute less to shareholder value. The negative association between value of cash (capital expenditure) and busy boards is mitigated in firms with (i) high advising needs, (ii) high external financing needs and (iii) less entrenched ownership structures.     

Labor unemployment risk and corporate financing decisions

This paper presents evidence that firms choose conservative financial policies partly to mitigate workers' exposure to unemployment risk. We exploit changes in state unemployment insurance laws as a source of variation in the costs borne by workers during layoff spells. We find that higher unemployment benefits lead to increased corporate leverage, particularly for labor-intensive and financially constrained firms. We estimate the ex ante, indirect costs of financial distress due to unemployment risk to be about 60 basis points of firm value for a typical BBB-rated firm. The findings suggest that labor market frictions have a significant impact on corporate financing decisions.     

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.     

Firm Size,Book-to-Market Ratio,and Security Returns: A Holdout Sample of Financial Firms

Fama and French (1992) document a significant relation between firm size, book-to-market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book-to-market ratios, and security returns is similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book-to-market premiums in returns. Our results indicate data-snooping and selection biases do not explain the size and book-to-market patterns in returns.