Securities Class Action Lawsuits Research Articles

Do Shareholders Prefer Institutional Lead Plaintiffs?

Previous research has documented that institutional lead plaintiffs are associated with higher settlements and marginal improvements to governance following securities class action lawsuits. In this study, we examine the market reaction to an institution being named as lead plaintiff to examine whether the market views the improvements in governance to be worth the higher costs. We find that the abnormal returns surrounding the announcement of an institutional lead plaintiff are significantly positive, and significantly larger than the negative market reaction to the appointment of a non-institutional lead plaintiff. However, we find only weak evidence showing that the reaction is more positive for firms in greater need of governance improvement, nor is the quality of governance a consideration in seeking to be lead plaintiff. Instead, our results suggest that the market reaction is more positive when institutions retain ownership in the defendant firm, suggesting that their long-term interests are seen as more aligned with other existing shareholders.

Abnormal stock returns and shorting around securities class action lawsuits: The role of pre-filing news releases

Studying 1,473 U.S. securities class action (SCA) lawsuits over 2009–2019, we find that the pre-filing abnormal negative returns and shorting are largely linked to public investigation news that precedes the SCA lawsuit filing. Across all the lawsuits, 73% of the total abnormal negative returns over the ten-day pre-filing period are attributed to the 31.6% of the cases that had investigation news over that pre-filing period. Our findings indicate that investors’ ability to anticipate SCA lawsuits is not as economically significant as previous studies suggest, and that SCA shorting profitability is substantially linked to analysis of public information.

Misstatement verifiability and managers’ earnings warning decisions

We examine whether the verifiability of misstatements in prior forward-looking earnings disclosures contributes to managers’ decisions to issue earnings warnings. Using securities class action lawsuits from 1996 to 2019 pertaining to forward-looking earnings disclosures, we find that earnings warnings are positively associated with the verifiability of misstatements in such disclosures. The results survive entropy balancing and firm-fixed effects to mitigate endogeneity concerns. The positive relation between earnings warnings and misstatement verifiability is more pronounced for firms 1) with a general counsel in the top management team and 2) that face higher ex-ante litigation risk, and less pronounced for firms whose managers engaged in insider selling during the class action lawsuit period. We also show that earnings warnings help to increase the likelihood of a lawsuit dismissal (i.e., lowering litigation costs) when the lawsuit involves misstatements that are more (rather than less) verifiable. Taken together, our findings suggest that managers issue earnings warnings when it helps to reduce litigation costs, consistent with the notion that managers can achieve a greater reduction in litigation costs by issuing earnings warnings.

The Dark Side of Investor Conferences: Evidence of Managerial Opportunism

ABSTRACT Although the shareholder benefits of investor conferences are well-documented, evidence on whether these conferences facilitate managerial opportunism is scarce. We examine whether managers opportunistically exploit heightened attention around the conference to “hype” the stock. We find that (1) managers increase the quantity of voluntary disclosure leading up to the conference, (2) these disclosures are more positive in tone and increase prices to a greater extent than post-conference disclosures, and (3) these disclosures are more pronounced when insiders sell their shares immediately prior to the conference. In circumstances where pre-conference disclosures coincide with pre-conference insider net selling, we find evidence of a significant return reversal––large positive returns before the conference and large negative returns after the conference––and that the firm is more likely to be named in a securities class action lawsuit. Collectively, our findings are consistent with some managers hyping the stock prior to the conference.

Shareholder litigation and short selling ahead of private equity placements

AbstractWe examine the impact of shareholder litigation on short selling ahead of private investments in public equity (PIPEs). We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE are shorted more heavily ahead of the PIPE issue. The case status at the PIPE date, the severity of the lawsuit, and the timing of the private placement after the litigation event also affect the extent of short selling activity ahead of PIPEs. Consistent with hedging incentives, the effects of prior shareholder litigation on short selling are more pronounced in PIPEs where lead investors are hedge funds and in traditional PIPEs.

Does Shareholder Litigation Risk Cause Public Firms to Delist? Evidence from Securities Class Action Lawsuits

Abstract Using three exogenous shocks to ex ante litigation risk, including federal judge ideology and two influential judicial precedents, we find that lower shareholder litigation risk reduces a firm’s propensity to delist from the U.S. stock markets. The effect is at least partially driven by indirect costs of litigation and that being a private firm can significantly reduce the threat of litigation. Overall, the results suggest that mitigating excessive litigation costs for public firms is crucial to ensure the continued vibrancy of the U.S. stock market.

Does the presence of a general counsel in top management affect securities class action lawsuits?

AbstractResearch Question/IssueThis study investigates the effect of the presence of a firm's general counsel on the top management team on the likelihood that a US publicly traded company is targeted by a securities class action (SCA).Research Findings/InsightsUsing a US sample of class action lawsuits against publicly traded companies, we provide evidence that firms whose top management includes the general counsel (TMC) are less likely to be involved in SCAs. We further investigate the association of the presence of a TMC with the subsequent four litigation outcomes: market reaction to the lawsuits, duration of the lawsuit process, dismissal of the lawsuit, and the settlement approved by the courts. We find that firms with a TMC experience more favorable consequences on all four dimensions of litigation outcomes. The results hold after controlling for endogeneity, unobserved firm‐related omitted variable bias, and monitoring mechanisms.Theoretical/Academic ImplicationsThe findings support that establishing a TMC acts as an effective governance mechanism in reducing corporate litigation risk and adverse legal outcomes.Practitioner/Policy ImplicationsOur evidence suggests that a TMC can help monitor operating and financial decisions. This study suggests that Section 307 of the Sarbanes–Oxley Act (SOX) works in terms of explicitly emphasizing the general counsel's responsibility. Thus, this study offers insights to policymakers who are interested in enhancing the function of the governance mechanism by which a corporate general counsel can influence the capital market.

Undisclosed material inflation risk

We identify many major U.S. corporations that are highly exposed to inflation risk. Yet, although the SEC legally requires disclosing possible risk factors, more than 61% of the inflation-exposed corporations do not disclose inflation risk. However, after being sued in a securities class action lawsuit, while all firms increase the length of their reported risk factor texts, only inflation-exposed firms are more likely to begin disclosing inflation risk. Simulations using calibrated parameters from our models reveal that 2%–6% inflation shocks over the subsequent three years result in market cap damages of $0.9 to $2.8 trillion for shareholders of inflation-exposed firms that never disclosed this risk. The inadequate inflation risk disclosure holds after allowing risk to be time varying, controlling for firm/industry characteristics, and/or exploiting a quasi-natural experiment that identifies causal effects and controls for possible unobservable factors. The evidence is consistent with corporate managers paying inadequate attention to inflation risk. Our framework enables identification and evaluation of stock price drop damages, especially for firms with inadequate risk disclosures, possibly improving disclosure practices, inflation expectations, and monetary policy transmission.

Disclosure Speed: Evidence from Nonpublic SEC Investigations

ABSTRACTWe examine cross-sectional variation in disclosure speed by using data that allow us to measure when managers learn of SEC investigations and the time lag until subsequent disclosures. We document that external monitoring and litigation risk are associated with 99 percent and 39 percent faster disclosure, and managerial entrenchment with 28 percent slower disclosure. When revelations by external parties preempt managers’ disclosures, we observe a significant increase in bid-ask spreads that persists for at least three years following the close of the investigation and a higher likelihood of turnover for less entrenched CEOs. We also document that firms whose managers disclose investigations are subject to fewer subsequent securities class action lawsuits. Our results are consistent with managers balancing the costs of fast disclosure, including immediate stock price declines and potential reputational costs, with the risks of having external parties leak news of SEC investigations.

Does litigation risk matter for managers’ asymmetric cost behavior?

This study examines the effect of litigation risk on firms’ asymmetric cost behavior. Using data on filings of securities class action lawsuits from 1999 to 2019, we find that firms’ asymmetric cost behavior increases with higher litigation risk. Furthermore, we find that the effect of litigation risk on cost stickiness is more pronounced in (1) labor-intensive firms, and (2) high-tech industries. Our study contributes to the literature by suggesting that litigation risk is a valuable determinant affecting firms’ asymmetric cost behavior.

Attracting the Sharks: Corporate Innovation and Securities Class Action Lawsuits

This paper provides novel evidence suggesting that securities class action lawsuits, a central pillar of the U.S. litigation and corporate governance system, can constitute an obstacle to valuable corporate innovation. We first establish that valuable innovation output makes firms particularly vulnerable to costly low-quality class action litigation. Exploiting judge turnover in federal courts, we then show that changes in class action litigation risk affect the value and number of patents filed, suggesting firms take into account that risk in their innovation decisions. A new perspective we provide is that innovation success, not only innovation failure, can increase firms’ securities class action litigation risk. This paper was accepted by Victoria Ivashina, finance. Funding: E. Kempf gratefully acknowledges financial support from the James S. Kemper Foundation at the University of Chicago Booth School of Business. Supplemental Material: Data and the internet appendix are available at https://doi.org/10.1287/mnsc.2022.4388 .

Shareholder Litigation and Corporate Social Responsibility

AbstractThis research examines the relation between shareholder litigation and corporate social responsibility (CSR). Exploiting exogenous changes in shareholder litigation rights following the staggered adoption of universal demand laws by U.S. states and the Ninth Circuit Court of Appeals’ ruling on securities class action lawsuits, we show that weaker shareholder litigation rights lead to lower CSR scores. Moreover, the relation is stronger for firms facing higher litigation risk, and a decreased CSR score enhances firm value. Our evidence suggests that firms engage in CSR activities partly to reduce shareholder litigation risk ex ante and mitigate its consequences ex post.

Corporate social responsibility and litigation risk: Evidence from securities class action lawsuits

AbstractThis study examines whether corporate social responsibility (CSR) is associated with the likelihood and outcomes of securities class action lawsuits. We find a lower likelihood of securities litigation for firms with higher CSR. This effect is larger for companies with lower levels of financial distress, companies with larger proportions of institutional investors, and for internal CSR. Additionally, CSR has a mitigating effect on negative market assessments around the filing dates of securities litigation. The results suggest that higher CSR firms are less likely to engage in financial misconduct, and investors are less likely to penalise them for such occurrences.

The effect of investor attention on fraud discovery and value loss in securities class action litigation

AbstractWe examine the effect of investor attention on value loss due to securities class action lawsuits and litigation‐based fraud discovery. We find that investor attention is positively associated with damage to corporate reputation and the magnitude of the value losses suffered by defendant firms. The reputational damage to defendant firms with higher investor attention is evident from poor operational performance and lower institutional ownership after filing. Investor attention is positively associated with the diffusion of information regarding fraud and it accelerates lawsuit filing. The effects of investor attention, however, are not subsumed by the severity of the fraud. Our results are robust to a battery of tests that addresses selection and endogeneity concerns.

Stock market signals and consequences of securities class actions lawsuits: a microstructure perspective

We perform a microstructure analysis of trading activities pre- and post-class period end-dates of securities class action lawsuits. We posit that these events are likely to significantly impact the spreads of affected firms, in addition to the well documented market capitalization loss that spurs the legal action. We detect neither meaningful widening of spreads nor change in put-call ratios ahead of the class period end-date, suggesting no microstructure or option open interest signal of the upcoming event. However, we present strong evidence of a significant degradation in market quality post the class period end-date based on widening spreads lasting for at least 60 trading days. We also document a trading volume spike and share price decline around the event date. Our research shows the impact on shareholders extends beyond the capitalization loss through wider spreads for defendant firms, while the same is not true for a control sample.

Measuring Audit Quality

In this paper, we document 45 specific allegations related to audit deficiencies based on GAAS, as detailed in 141 AAERs and 153 securities class action lawsuits over the violation years 1978–2016. Next, we use these allegations to validate existing popular proxies of audit quality. Of all the audit quality proxies, we find that restatements consistently predict all of the top six most cited audit deficiencies. The ratio of audit fees to total fees and the presence of a city specialist auditor predict five of the most cited deficiencies. Overall, our results suggest that the predictive power of audit quality proxies depends on (i) the settings that researchers are interested in; and (ii) the specific audit deficiencies hypothesized to matter in the investigated setting. For instance, future studies related to auditor independence might consider using restatements and the ratio of audit fees to total fees as proxies of audit quality.

The Mitigation of Reputational Risk via Responsive CSR: Evidence from Securities Class Action Lawsuits

The Mitigation of Reputational Risk via Responsive CSR: Evidence from Securities Class Action Lawsuits

Law firm market share and securities class action litigation outcomes

Using a large sample of securities class action lawsuits, we examine the association of law firm market share with litigation outcomes. We find lawsuits with top market share plaintiff law firms are less likely to be dismissed and take longer to be dismissed and to reach settlement. In contrast, lawsuits with top defendant law firms reach settlement faster. Top market share defendant law firms are neither associated with suit dismissal nor with speed of dismissal. Finally, neither top plaintiff nor top defendant law firms are associated with the cash and/or total settlement amount. These results suggest plaintiff and/or defendant law firm market share is an important factor in securities class action litigation outcomes. The results favor the view that plaintiff and defendant law firms with a higher market share are more reputable and better serve the interests of their respective clients in securities class action litigations.

The effect of securities class action lawsuits on mergers and acquisitions

This paper investigates whether shareholder class action litigation affects the takeover candidacy, premium, and completion rate of mergers and acquisitions involving defendant target firms. We use a comprehensive dataset of publicly traded U.S. firms that became the targets of takeover bids between 1998 and 2016 and find that firms subject to shareholder class action lawsuits within the previous two years are more likely to be targeted for acquisition while commanding a significantly higher premium. Firms that face such litigation after a takeover announcement experience a significant decrease in takeover completion.

Identifying Ineffective Monitors from Securities Class Action Lawsuits

We identify “ineffective” institutional monitors based on the prevalence of occurrences of securities class-action lawsuits in the investors’ overall portfolio. We find that firms with a higher representation of such institutional investors among the firms’ large shareholders have a greater likelihood of future litigation. These firms consistently exhibit other unfavorable governance outcomes including poorer acquisition outcomes and lower CEO turnover-performance sensitivity. Moreover, firms owned by “ineffective” institutional investors experience higher short interest, suggesting that the market anticipates underlying managerial agency issues. Overall, our results suggest that class-action lawsuits provide an opportunity to uncover the monitoring effectiveness of large institutional shareholders.