Shareholder Litigation and Insider Trading: Evidence from Derivative Lawsuits

Abstract

We examine whether shareholder litigation deters informed insider trading, utilizing the staggered adoptions of Universal Demand (UD) laws by different states. The UD laws substantially raise the hurdle for shareholders to file derivative litigation. We find that corporate insiders significantly increase opportunistic trades, including both insider purchases and sales, after the passage of UD laws, suggesting derivative litigation serves a disciplinary role in curbing insider trading. The deterrence effect of derivative litigation complements that of federal securities litigation, as it is useful in reducing informed insider trading activity unaccompanied by investor losses such as insider purchases. The deterrence effect on insider trading is more pronounced for firms with limited media coverage and high information asymmetry, and for corporate insiders facing less risk of other enforcement actions. Overall, our evidence suggests that shareholder litigation in the form of derivative litigation plays a unique role in curbing informed insider trading.