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Effects of securities class action litigation on corporate liquidity and investment policy

Subject

Finance

Publishing details

IFA Working Paper

Authors / Editors

Arena M;Julio B

Publication Year

2013

Abstract

The risk of being involved in a securities class action litigation alters corporate savings and investment policy. We employ industry spillover effects to identify the impact of changes in the likelihood of litigation on firm behavior. Firms with greater exposure to securities litigation hold significantly more cash in anticipation of future settlement costs, controlling for the other determinants of corporate liquidity policy. The result is due to firms accumulating cash in anticipation of lawsuits and not a consequence of plaintiffs targeting firms with high cash levels. The value of an additional dollar of cash is significantly lower for firms exposed to litigation risk. We also find that corporate investment decisions are affected by litigation risk, as firms cut back on capital expenditures in response to increases in litigation risk. Our results are robust to different proxies of litigation risk, endogeneity concerns, firm characteristics, and possible spurious temporal effects. Our results suggest that firms follow a risk management strategy in which they partially hedge with limited insurance contracts and adopt a more conservative capital structure through the accumulation of cash.

Keywords

Cash Holdings, Litigation Risk, Risk Management; Corporate Investment

Series

IFA Working Paper

Available on ECCH

No


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