Empirical Studies of Corporate Law

1

• Empirical Studies of Corporate Law
• Sanjai Bhagat
• Professor of Finance, University of Colorado at
  Boulder
• and
• Roberta Romano
• Allen Duffy/Class of 1960 Professor of Law, Yale
  University, NBER and ECGI
• for Handbook of Law and Economics
• edited by A. Mitchell Polinsky and Steven Shavell
• Harvard Law School
• Cambridge, MA

2
Stock Market Response for Defendant Corporations
by Opponent type
3
Shareholder Wealth Implications of Corporate
Lawsuits

• Table 1, Panel A Announcement period abnormal
  returns for defendant corporations by opponent
  type.
• At filing Large negative impact when government
  is the plaintiff.
• On settlement Large positive impact when another
  corporation is the plaintiff.
• Table 1, Panel B Announcement period abnormal
  returns at filing for plaintiff corporations by
  opponent type
• Non-positive market reaction for plaintiffs in
  most cases.
• Positive impact in antitrust cases when other
  side is another corporation.
• Table 1, Panel C Announcement period abnormal
  returns for defendant corporations by type of
  legal issue.
• Large negative impact on filing for
• Environment suits
• Fraud of government
• Financial reporting fraud

4
Stock Market Response for Plaintiff Corporations
by Opponent type
5
Stock Market Response forDefendant Corporations
by Type of Legal Issue
6
Shareholder Wealth Implications of Corporate
Lawsuits

• Bhagat, Brickley and Coles (JFE, 1994)
• Bhagat, Bizjak, and Coles (FM, 1998)
• Bhagat and Romano (ALER, 2002a 2002b)
• Costs and benefits of
• Filing a lawsuit
• Settling
• Going to trial
• Likely to be a function of
• Type of suit (antitrust, disclosure laws, etc.)
• The opposition (government, another corporation,
  etc.)

7
Shareholder Wealth Implications of Corporate
Lawsuits

• Suits involving Corporations and Government
  Entities
• Net Present Value (NPV) Present value of
  benefits Present value of costs.
• Corporate managers take actions in litigation
  that have positive NPV, and eschew courses of
  action that have negative NPV. Reasonable
  approximation assuming
• Alignment of management incentives with
  shareholders.
• Firms low cost of access to capital markets.
• Government decision-makers unlikely to use the
  NPV rule.

8
Shareholder Wealth Implications of Corporate
Lawsuits

• Suits involving Corporations and Government
  Entities
• Government decision-makers unlikely to use the
  NPV rule.
• Less constrained by financial and legal
  resources.
• Incentive to overspend legal resources in a suit.
• Some cases define agency or government powers.
• Visibility associated with winning can affect
  survival and funding of government unit.
• Opposing corporations face free-rider problems.
  Winning a suit and establishing a legal precedent
  can provide benefits for many firms, but the
  entire cost of the suit is absorbed by the
  litigating corporation.
• Coase Theorem Private litigants have an
  incentive to settle a dispute when doing so would
  be mutually economically beneficial.

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Shareholder Wealth Implications of Corporate
Lawsuits

• Suits involving Corporations and Government
  Entities
• Government decision-makers unlikely to use the
  NPV rule.
• Litigation-related financial distress costs
  (terminated trade credit, lower market value of
  warranties) is an important determinant of the
  change in shareholder wealth for corporations.
  While government agencies face the possibility of
  decreased funding or elimination, they do not
  face the usual costs of financial distress.
• Sued firms risk debarment from government
  contracts, an exclusion that potentially
  represents a huge loss.
• Government lawsuits can attract large publicity,
  resulting in larger reputational losses.

10
Shareholder Wealth Implications of Corporate
Lawsuits

• Interfirm Suits (involving corporations as
  plaintiffs and defendants)
• Corporate managers take actions in litigation
  that have positive NPV, and eschew courses of
  action that have negative NPV.
• Importance of financial distress costs (fdc).
• Direct fdc in bankruptcy legal administrative
  fees Small.
• Indirect fdc prior to bankruptcy Large.

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Shareholder Wealth Implications of Corporate
Lawsuits

• Interfirm Suits (involving corporations as
  plaintiffs and defendants)
• Indirect fdc prior to bankruptcy Large. Costs
  include
• Lower sales.
• Inability to do business with customers and
  suppliers on favorable terms.
• Greater difficulty of raising funds or obtaining
  credit.
• Distraction of management.
• Inefficient investment policy. (underinvestment.d
  oc http//leeds.colorado.edu/faculty/bhagat)
  With risky debt outstanding, managers sometimes
  pass up profitable opportunities.

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Shareholder Wealth Implications of Corporate
Lawsuits

• Suits involving corporations and private citizens
• Reduced access to capital markets by most private
  citizens imply reduced ability to litigate, and
  smaller wealth effects on firms.
• Some suits filed by individuals foreshadow a mass
  tort, a class action, or multiple follow-on
  suits, or motivate government litigation. In such
  cases, wealth implication on corporation could be
  substantial.

13
Shareholder Wealth Implications of Corporate
Lawsuits

• Legal Issue affects cost of a lawsuit and
  behavior in suit settlement and trial.
• Certain types of violations carry large
  penalties.
• Trebling of damages in antitrust suits.
• Large punitive damage awards.
• Class action or multiple follow-on suits.
• Differing reputational costs.
• High for product-liability and environmental
  cases.
• Low for antitrust cases.
• Differing impact on other customers and
  suppliers.
• Plaintiff in a patent infringement dispute might
  be more likely to incur the costs of a trial to
  prevent the defendant from profiting and to
  discourage other firms from violating the patent.
• Plaintiff in a breach of contract suit may be
  more likely to settle a suit to maintain good
  relations with the defendant-supplier and other
  potential suppliers who could observe the formal
  dispute.

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Shareholder Wealth Implications of Corporate
Lawsuits

• Conclusions
• Lawsuits are not a value-enhancing way for
  corporations to settle their disagreements with
  other corporations.
• The market appears to impose a higher sanction on
  firms than actual legal sanctions.
• KL (1993, 1999) criminal restitution, civil
  penalties and court costs comprise only about 7
  percent of the shareholder wealth loss. Remaining
  93 percent can be attributed to the reputational
  loss suffered by the defendant firms.