Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms

69 Pages Posted: 23 Mar 2010 Last revised: 6 Sep 2017

See all articles by Lynn Bai

Lynn Bai

University of Cincinnati - College of Law

James D. Cox

Duke University School of Law

Randall S. Thomas

Vanderbilt University - Owen Graduate School of Management; Vanderbilt University - Law School

Date Written: March 18, 2010

Abstract

Private suits have long been championed as a necessary mechanism not only to compensate investors for harms they suffer from financial frauds but also to enhance the deterrence of wrongdoing. But many critics have claimed that there a hidden dark side to the successful prosecution of a securities class action. In this paper, we shed light on these issues by examining whether the revelation of earlier misstatements, the initiation of private suit, and the payment of a substantial settlement, weaken the defendant firm so that the firm is permanently worse off as a consequence of the settlement.

We find that defendant firms that settle securities class actions experience no significant declines in sales opportunities as a result of the lawsuit and settlement, but do experience a reduced level of operating efficiency while the lawsuit was pending (but not after it is settled). Most significantly, we also observe that defendant firms experience liquidity problems post-settlement and worsening Altman Z-scores (and a greater propensity to file bankruptcy) during that time period as well. Beginning with the filing of the class action, firm share prices are punished to the extent that investor returns do not recover.

We conclude that there is something in our results for both sides of the debate regarding the effects of securities litigation. One side could point toward our findings as evidence that the litigation is not a zero sum game for wrongdoers where only the insurer pays. On the other hand, others would claim that settlements, if not the entire litigation process, are a menace because they drain funds from the corporation that could better be directed toward strengthening its financial position.

Keywords: Empirical Study, Securities Class Actions

Suggested Citation

Bai, Lynn and Cox, James D. and Thomas, Randall S. and Thomas, Randall S., Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms (March 18, 2010). University of Pennsylvania Law Review, Vol. 158, July 2010, Vanderbilt Law and Economics Research Paper No. 10-09, U of Cincinnati Public Law Research Paper No. 10-16, Available at SSRN: https://ssrn.com/abstract=1574447 or http://dx.doi.org/10.2139/ssrn.1574447

Lynn Bai

University of Cincinnati - College of Law ( email )

P.O. Box 210040
Cincinnati, OH 45221-0040
United States
513-556-0194 (Phone)

James D. Cox

Duke University School of Law ( email )

210 Science Drive
Box 90362
Durham, NC 27708
United States
919-613-7056 (Phone)
919-613-7231 (Fax)

Randall S. Thomas (Contact Author)

Vanderbilt University - Owen Graduate School of Management

401 21st Avenue South
Nashville, TN 37203
United States

Vanderbilt University - Law School ( email )

131 21st Avenue South
Nashville, TN 37203-1181
United States

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