The Reaction of Firm Ex Ante Cost of Equity Capital to Initiation and Resolution of Shareholder Lawsuits

Abstract

In this manuscript, I examine the firm’s ex ante cost of equity capital in the quarter before and the quarter after the filing of a shareholder securities lawsuit as well as in the quarter before and the quarter after the final resolution of the shareholder lawsuit. I find that the adjustment in firm ex ante cost of equity capital is dependent on the probable outcome of the case, as estimated on the shareholder lawsuit filing date. If, at the time of filing, the probability of a favorable outcome for the firm (dismissal or win) is relatively higher, the effect of the shareholder lawsuit on firm ex ante cost of equity capital is low. In contrast, a high probability of a settlement or a loss for the firm results in a greater increase in firm ex ante cost of equity capital. In examining firm ex ante cost of equity capital in the quarter before and after the final resolution of the shareholder lawsuit, I find that firm ex ante cost of equity capital adjusts only when the final resolution of the case is different than initial probability estimates. Consequently, a firm may see adjustments to its cost of equity capital either at the time the lawsuit is filed or when the outcome of the lawsuit is determined, or both.