Private Class Action Litigation Risk of Chinese Firms Listed in the US

Abstract

We analyze the litigation risk of Chinese firms listed in the US. We find that firm-specific characteristics from prior literature studying US firms are not correlated with the litigation risk of US-listed Chinese firms. However, our findings indicate that the method of listing is the only reliable predictor of litigation risk — firms listing via reverse merger are significantly more likely to face lawsuits compared to firms listing via initial public offering (IPO). We find that Chinese reverse merger (CRMs) firms, relative to Chinese IPOs, have lower analyst following, similar post-listing stock performance, higher operating cash flows, smaller size, and lower cash holdings. We conclude that the litigation risk differential is consistent with the bonding hypothesis of [Stulz 1999, Globalization of Equity Markets and the Cost of Capital, Journal of Applied Corporate Finance 12, 8–25], wherein the higher litigation risk of CRMs is a reflection of increased but varying levels of monitoring, starting with the regulatory oversight at the pre-listing stage and a post-listing tradeoff between enforcement and monitoring by shareholders.