The Private Securities Litigation Reform Act of 1995: the stock market casts its vote…

In December 1995, Congress overrode a presidential veto to enact the Private Securities Litigation Reform Act. This legislation was aimed at curbing abuses in class action securities litigation, and providing firms with relief from frivolous lawsuits brought on the basis of stock price volatility. While the intent of lawmakers in drafting this legislation was clear, the impact of the Reform Act for shareholders of firms that are likely targets of securities litigation was uncertain. In particular, it was unclear if the cost savings from reduced litigation would outweigh the potential losses due to decreased protection from fraudulent managers, and it was also unclear if the impact of the legislation would differ for firms with different governance structures. This paper provides an economic answer to these questions by analyzing the stock market's response to the initial passage, the veto, and subsequent veto override of the Reform Act. We examine the stock price performance of firms in four industries-biotechnology, computers, electronics, and retailing-that are likely to be affected by securities litigation reform. We document a significantly negative stock price response to rumors of the presidential veto and a significantly positive response to the subsequent House override vote, indicating that investors agreed with Congress that the positive effects of the Act predominate. We also examine reactions across subsets of firms with different levels of institutional ownership, different levels of insider ownership and with different board structures, and find evidence that the positive factors outweigh any increased susceptibility to managerial fraud or inability to bring meritorious suits, even among firms with weak internal governance structures. © 1997 John Wiley & Sons, Ltd.