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Liquidity Effects of Litigation Risk: Evidence from a Legal Shock

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Abstract

Theory offers two diverging views on the effects of ex-ante litigation risk on corporate liquidity proxied by cash holdings. Ex-ante litigation risk, however, is difficult to measure. We test the liquidity effects of ex-ante litigation risk exploiting the phase-by-phase introduction of securities class actions (SCAs) in Korea. Following the increase in litigation risk, firms significantly increase their internal liquidity, especially in firms without D&O insurance coverage or those that are financially constrained. The results hold robustly in differences-in-differences and regression discontinuity designs. We also find that the increase in ex-ante SCA risk improves firms’ stock market liquidity and valuation especially in firms that do not carry D&O insurance. Taken together, the results are consistent with the deterrence and protection effects of SCAs that increase firms’ liability risk and lower the risk that investors face in investing in firms.

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  • Tommaso Oliviero & Min Park & Hong Zou, 2021. "Liquidity Effects of Litigation Risk: Evidence from a Legal Shock," CSEF Working Papers 623, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 21 Jan 2023.
    • Handle: RePEc:sef:csefwp:623
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    1. Choi, Seungho & Gam, Yong Kyu & Kim, Yong Hyuck & Shin, Hojong, 2024. "The effect of ex ante litigation risk on corporate fraud: Evidence from securities class action act in Korea," Finance Research Letters, Elsevier, vol. 64(C).

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    More about this item

    Keywords

    Liquidity; cash holdings; valuation; litigation risk; class action; difference-in-differences; regression discontinuity.;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law

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