Universal Demand Laws Research Articles

Corporate culture and shareholder litigation rights: evidence from a quasi-natural experiment and textual analysis

PurposeTaking advantage of an innovative measure of corporate culture obtained from advanced machine learning and textual analysis, we investigate how corporate culture is influenced by shareholder litigation rights, which are widely recognized as a crucial external governance mechanism. The innovative measure of corporate culture is based on a textual analysis of over 200,000 earnings call transcripts.Design/methodology/approachTo mitigate endogeneity and thus demonstrate causality, we exploit a quasi-natural experiment based on the staggered passage of universal demand laws, which reduce shareholder litigation rights. The enactment of state-level legislation is likely exogenous to individual firms’ characteristics as it is beyond the control of any given firm. Following the literature, we employ a difference-in-difference analysis, supplemented by several robustness checks, i.e. propensity score matching and entropy balancing.FindingsOur difference-in-difference estimates show that an exogenous reduction in shareholder litigation rights weakens corporate culture considerably. Specifically, corporate culture is 12.74–14.41% weaker after the implementation of universal demand laws. Our results corroborate the hypothesis that a decline in litigation risk exacerbates agency problems, discouraging self-interested managers from taking actions that enhance shareholder value in the long run, such as cultivating a strong corporate culture.Originality/valueOur study is the first to explore how corporate culture is affected by shareholder litigation risk, which constitutes a vital external governance mechanism. Moreover, we utilize an innovative measure of corporate culture based on sophisticated textual analysis. Finally, we employ a quasi-natural experiment based on an exogenous shock, making it more likely that our conclusion reflects a causal influence rather than merely a correlation.

Over-hedging in the shadow of weaker litigation threat

Using the staggered adoption of universal demand (UD) laws by U.S. states over the period 1997–2010 as a quasi-natural experiment, we examine the impacts of weakened shareholder litigation rights on corporate financial risk management. We find that firms facing reduced litigation threats post-UD law adoption engage in more currency hedging, coupled with decreases in firm value. The increase in risk management is particularly pronounced for firms with higher pre-existing litigation risk, weaker governance structures, and greater managerial entrenchment. Our evidence suggests that diminished shareholder litigation threat incentivizes managers to over-hedge to protect their own interests rather than maximize shareholder value.

Corporate sustainability and biodiversity reporting: A proactive business strategy to mitigate litigation and reputational risks

AbstractBiodiversity is important to human's future survival and global sustainability. One way to achieve corporate sustainability is for firms to report its impacts on biodiversity. However, fear of litigation arising from reporting potentially deters corporations to disclose such information. Motivated by the importance of biodiversity and mixed evidence of shareholder litigation rights as a corporate governance tool, we explore whether the universal demand laws (UDLs) have any effect on corporate biodiversity reporting in the United States. Supporting our short‐termism, risk aversion and agency hypotheses, we find that an exogenous decline in the threat of derivative litigation, reducing a chance for shareholders to file a lawsuit against top management and intensifying agency costs, economically and significantly decreases a corporate's biodiversity reporting by 87%. When the disciplining effect of shareholder litigation drops, the self‐interest manager may want to live a quiet life and disclose less information of biodiversity impact. A proactive business strategy to mitigate litigation and reputational risks is to voluntarily disclose more biodiversity‐related information. Regulators around the world should also promote rigorous reporting requirements to reverse biodiversity loss and save our humanity.

Shareholder litigation risk and stock returns

AbstractExamining the staggered adoption of universal demand (UD) laws as an exogenous shock to shareholder litigation risk, we show that firms have lower stock returns following that adoption in a difference‐in‐differences (DID) design and Fama and MacBeth (1973) regression. Sorting stocks into UD laws portfolios, we show that firms adopting UD laws earn lower risk‐adjusted returns than those who do not. Further, the relation between UD laws and returns is more pronounced when firms face financial constraints, CEOs engage in high risk taking, or takeover protection is low.

EXPRESS: So, Sue Me … If You Can! How Legal Changes Diminishing Managers’ Risk of Being Held Liable by Shareholders Affect Firms’ Likelihood to Recall Products

Research examining the antecedents instead of consequences of recalls is relatively sparse and has not considered whether firms’ likelihood to recall products is influenced by legal changes that could induce managerial opportunism, such as those reducing shareholder litigation risk. To examine this question, the authors exploit the staggered adoption of universal demand (UD) laws across different states in the U.S. as a quasi-natural experiment. UD laws aim to prevent frivolous litigation from disrupting a firm’s normal business operations by making it more difficult for shareholders to sue managers for neglecting their fiduciary duties and hold them personally liable. Although UD laws are well-intended, the reduced threat of shareholder litigation disciplining a firm’s managers could have unintended negative consequences. Indeed, using a difference-in-differences (DiD) analysis, the authors find that following the adoption of UD laws, affected firms become less likely to recall products. This effect is weaker in the presence of organizational mechanisms constraining managers’ self-interest-seeking behavior, such as a corporate culture focused on customer needs and interests or the exercise of normative control through monitoring by institutional investors. The authors do not find support for a potential alternative explanation of operational improvement and therefore higher product quality driving their findings.

Shareholder Litigation Rights and Tax Avoidance: Evidence From Universal Demand Laws

Shareholder Litigation Rights and Tax Avoidance: Evidence From Universal Demand Laws

Litigating payouts or not? Evidence from universal demand laws

Anecdotal evidence suggests that high litigation risk may induce firms to reduce payouts. By contrast, litigation can be an effective governance tool for shareholders to claim payouts. To examine which view dominates, we exploit the staggered adoption of universal demand (UD) laws across various U.S. states, which raise the hurdle of filing derivative lawsuits and reduce the ex-ante litigation risk of affected firms as quasi-exogenous shocks to examine the effect of litigation risk on firms' payouts. We find that the adoption of UD laws leads to a significant increase in a firm's payouts, i.e., higher litigation risk discourages payouts. In particular, reduced litigation risk discourages the emission of cash dividends and encourages the initiation of share repurchases. The main effect is more pronounced for firms faced with higher litigation risk, that are more financially distressed, and that operate in more competitive product markets. Our overall findings suggest that excessive threats of derivative lawsuits may dampen financial flexibility and deter the distribution of cash to shareholders.

Shareholder litigation rights and firm productivity

AbstractThis paper analyzes the impacts of decreased shareholder litigation risk on firm productivity. Shareholder litigation provides shareholders a mechanism to enforce rights and mitigate agency conflicts. We use a staggered state‐level adoption of universal demand (UD) laws as an exogenous shock that suppressed the number of shareholder derivative lawsuits. We show that the resulting deterioration in corporate governance, coupled with increased managerial attention, had mixed effects on productivity. Adverse effects resulting from lower litigation risk are primarily observed in firms facing low takeover threats. Conversely, firms with incentivised management achieved a higher productivity growth.

Shareholder litigation and workplace safety

Using the staggered adoption of Universal Demand (UD) laws at the state level that increased the hurdle of shareholder derivative suits as a shock, we find that reduced litigation threat increases workplace injury rates. The effect is more pronounced for treated firms facing higher litigation risk, less product market competition, in low union coverage industries, and with Employee Stock Ownership Plans (ESOPs). Treated firms with high ownership by “dedicated” or local institutional investors are less affected as these investors can monitor safety through voice and exit. Safety inputs fall in treated firms following the adoption of UD laws. Overall, the findings suggest that shareholder litigation threat plays a critical role in workplace safety.

Managerial litigation risk and auditor choice

Our study investigates the causal relationship between managerial litigation risk and auditor choice decisions. Exploiting the staggered adoption of universal demand (UD) laws at the state level in the United States, we use a stacked regression approach and find a lower propensity for affected firms to switch to higher‐quality auditors after the exogenous reduction of managerial litigation risk. This result supports the managerial entrenchment hypothesis that lower litigation risk leads to more managerial entrenchment, which allows managers to be opaque in order to enjoy private benefits. This negative effect is mitigated for firms with more audit committee industry expertise and for firms that are more reliant on external finance. Our study contributes to our understanding of how regulatory changes that have an impact on agency problems affect firms' demand for auditing.

Managerial litigation risk and corporate investment efficiency: Evidence from universal demand laws

AbstractWe examine the effect of managerial litigation risk on corporate investment efficiency. Exploiting the staggered adoption of universal demand (UD) laws in the United States and employing a stacked regression approach, we find that the exogenous reduction in litigation risk induced by UD laws leads to lower investment efficiency. Our results are robust to the use of alternative partitioning variables and variations in sample composition. We also find that the decrease in investment sensitivity and excessive risk‐taking are channels through which the reduced litigation rights lead to less efficient investments. Our results support the notion that weakened shareholder litigation rights lead to more severe agency conflicts and thus less efficient investment decisions.

Shareholder litigation and toxic releases

AbstractWe examine the environmental impact of the staggered adoption of universal demand laws by 23 U.S. states between 1989 and 2005. Universal demand laws impede derivative lawsuits and thus undermine shareholder oversight of corporate environmental performance. We find that weakened litigation rights for shareholders are positively associated with the release of toxic chemicals by firms. The effect is stronger for firms with weak governance, and environmental mismanagement by firms after the passage of the laws lead to poorer financial performance. Overall, our findings imply that derivative lawsuits by shareholders are not frivolous, as is often asserted. Rather, they act as an effective mechanism of corporate governance.

Shareholder litigation and bank risk

Does a decrease in shareholder litigation enhance managers’ monitoring efforts by ensuring adequate firm risk management? We explore how state universal demand (UD) laws (which limit shareholder litigation as a mechanism to discipline managers), affect bank holding companies’ (BHCs) risk. Using a difference-in-differences analysis, we show that BHCs reduce their tail risk exposures after the implementation of UD laws, which is achieved by improving loan asset quality. Indeed, BHCs appear to apply stricter contract terms for syndicate loans to risky and opaque borrowers. We also show that UD law implementation leads to changes in BHC board composition by increasing the proportion of outside directors, the number of independent directors in audit committees and the number of independent directors with financial expertise.

Shareholder litigation rights and ESG controversies: A quasi-natural experiment

Leveraging as a quasi-natural experiment the staggered passage of universal demand laws, which raise the difficulty of shareholder lawsuits, we examine the effect of shareholder litigation rights on ESG controversies. Our difference-in-differences estimates show that an exogenous decline in shareholder litigation risk results in a significant drop in ESG controversies. Specifically, ESG controversies fall by 40.85% in response to an exogenous reduction in litigation risk. When more insulated from shareholder litigation, managers prefer to live a quiet life, intentionally avoiding risky and contentious activities, which require more managerial time and effort. Additional analysis validates the results, including propensity score matching, entropy balancing, and Oster's (2019) testing of coefficient stability. Finally, we find that ESG controversies erode firm profitability considerably, consistent with the theoretical expectations.

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.

Shareholder Litigation Risk and Firms’ Choice of External Growth

AbstractWe provide novel evidence showing that shareholder litigation risk influences firms’ choices of external growth strategies. Using staggered adoption of universal demand (UD) laws, we find that firms under the threat of litigation tend to choose corporate alliances over mergers and acquisitions (M&As). This finding supports the view that alliances offer a low-risk and low-cost alternative to M&As for firms facing litigation risk. Moreover, alliance performance improves after the passage of UD laws, suggesting that firms can make better deal selections under reduced litigation threats. Overall, we establish an unexplored link between litigation risk and firms’ choices of boundary-expanding transactions.

The dark side of weakening shareholder litigation rights: Evidence from green patenting activities

Exploiting the staggered adoption of universal demand (UD) laws as a quasi-natural experiment and the difference in difference approach, we find that US firms in states that adopted UD laws reduced their green innovation output and quality relative to their counterparts. Moreover, the causal relationship is more pronounced for firms that had better external governance before the adoption of UD laws. We also document that firms’ information asymmetry dramatically increases after UD laws enforcement. Overall, our study reveals the negative consequences of weakening shareholder rights on social welfare outcomes like environmental innovation productivity.

Identifying Corporate Governance Effects:The Case of Universal Demand Laws

Identifying Corporate Governance Effects:The Case of Universal Demand Laws

Shareholder litigation rights and labor investment efficiency

This paper investigates the effect of shareholder litigation rights on labor investment efficiency. Using a difference-in-differences approach based on the staggered adoption of universal demand (UD) laws, we find that firms incorporated in states that have adopted UD laws experience lower labor investment efficiency. Furthermore, the negative association between UD law adoption and efficient labor investment is more concentrated in firms exposed to higher shareholder litigation risk ex ante and high-skilled labor firms. Our evidence is consistent with the notion of the passage of UD laws strengthens agency problems, and thus reduces labor investment efficiency.

The need to validate exogenous shocks: Shareholder derivative litigation, universal demand laws and firm behavior

Several recent studies argue that the adoption of universal demand (UD) laws represent an exogenous decline in litigation risk by increasing the procedural hurdles associated with shareholder derivative litigation. This study examines how UD laws affect the incidence of derivative litigation risk and related decisions. We show that the adoption of UD laws had no meaningful impact on derivative litigation from 1996 to 2015. We also find no evidence that UD laws affect aggressive accounting, voluntary disclosure, executive compensation, or corporate governance decisions. Collectively, our findings cast doubt on the validity of using UD laws as an exogenous shock to litigation risk.