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Shareholder litigation: share price movements, news releases, and settlement amounts

Author

Listed:
  • James D. Beck

    (Consulting Group, Smith Barney, Inc., USA)

  • Sanjai Bhagat

    (Graduate School of Business, University of Colorado, Boulder, CO 80309-0419, USA)

Abstract

Under SEC Rule 10b-5, shareholders can sue a corporation that they believe has materially misled them about the firm's prospects. Recent legislation calls for reform of the rules governing shareholder class action litigation. Writers for the business press and experts testifying before the US Congress have argued that such litigation is largely frivolous in that attorneys target firms with highly volatile stock return histories, and litigated price drops are caused by return sensitivity to contemporaneous market movements. Further, they argue that the legal structure surrounding shareholder litigation produces excessive settlements based on the target firms' fear of large jury verdicts. This paper examines volatility and market sensitivity for both sued and nonsued firms. The approach is different from that of earlier papers in several ways. First, rather than selecting an arbitrary period prior to the lawsuit filing date, we examine both the financial performance and news-release characteristics of sued firms during the alleged misleading information period (MIP) of the suit: that is, during the period in which investors allege the firm misled the market. Second, we divide the lawsuit sample into categories depending on the allegations in the suit and the proximity of the MIP to the disclosure that caused the suit. Third, sued and nonsued firm samples are larger than those in earlier papers; for example, our sued firm sample includes 491 observations. Comparison group samples have also been broadened to include industry, size, past behavior of sued firms, and firms acquitted of the charges. We find that sued firms are more likely to experience episodes of very poor price performance than the population of nonsued firms. Sued firms exhibit higher systematic risk than the population of nonsued firms. Prior to the alleged misleading information period, sued firms experience abnormal positive returns for about 3 years. However, during the misleading information period, sued firms experience significant negative abnormal return. Sued firms issue more positive news in the MIP than matched groups of nonsued firms. Finally, we find that settlement values are significantly positively related to the seriousness of allegations in the suit, the length of time during which the shareholders allege they were misled, and to the overly optimistic tone of announcements about the firm during this misleading information period. © 1997 John Wiley & Sons, Ltd.

Suggested Citation

  • James D. Beck & Sanjai Bhagat, 1997. "Shareholder litigation: share price movements, news releases, and settlement amounts," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 18(7-8), pages 563-586.
  • Handle: RePEc:wly:mgtdec:v:18:y:1997:i:7-8:p:563-586
    DOI: 10.1002/(SICI)1099-1468(199711/12)18:7/8<563::AID-MDE853>3.0.CO;2-A
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    Citations

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    Cited by:

    1. Agnes Cheng, C.S. & He Huang, Henry & Li, Yinghua & Lobo, Gerald, 2010. "Institutional monitoring through shareholder litigation," Journal of Financial Economics, Elsevier, vol. 95(3), pages 356-383, March.
    2. Paul Sergius Koku & Anique A. Qureshi, 2006. "Analysis of the effects of settlement of interfirm lawsuits," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 27(4), pages 307-318.
    3. Robert Jones & Yan Wu, 2010. "Executive compensation, earnings management and shareholder litigation," Review of Quantitative Finance and Accounting, Springer, vol. 35(1), pages 1-20, July.
    4. Johnson, Marilyn F. & Nelson, Karen K. & Pritchard, Adam C., 2002. "Do the Merits Matter More? Class Actions under the Private Securities Litigation Reform Act," Berkeley Olin Program in Law & Economics, Working Paper Series qt6t80b57r, Berkeley Olin Program in Law & Economics.
    5. McTier, Brian C. & Wald, John K., 2011. "The causes and consequences of securities class action litigation," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 649-665, June.
    6. Ivan Brick & N. Chidambaran, 2008. "Board monitoring, firm risk, and external regulation," Journal of Regulatory Economics, Springer, vol. 33(1), pages 87-116, February.
    7. Habib, Ahsan & Jiang, Haiyan & Bhuiyan, Md. Borhan Uddin & Islam, Ainul, 2014. "Litigation risk, financial reporting and auditing: A survey of the literature," Research in Accounting Regulation, Elsevier, vol. 26(2), pages 145-163.
    8. Sergius Koku, Paul, 2006. "An analysis and the effects of class-action lawsuits," Journal of Business Research, Elsevier, vol. 59(4), pages 508-515, April.

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