Do M&A Lawsuits Discipline Managers' Investment Behavior?

Using securities lawsuits related to M&A as an industry shock, the authors examine whether litigation risk acts as an external governance mechanism by disciplining managers' investment decisions. In the two years following an M&A lawsuit (a lawsuit where plaintiffs allege that the firm hid poor performance related to a prior acquisition), they find that industry peers experience higher bidder announcement returns, choose more adequate methods of payment, and engage in fewer diversifying and smaller takeovers. Collectively, this evidence is consistent with post lawsuit deals being of higher quality. Furthermore, the authors find that peer firms respond to the increased litigation risk by reducing abnormally high investment expenditures. Finally, the reactions are stronger among firms with fewer anti-takeover provisions. Overall, their results show that M&A lawsuits can have an industry-wide deterrence effect on firms' suboptimal investment behavior.