What Happens in Nevada? Self-Selecting into Lax Law

Abstract:     
This paper finds that Nevada, the second most popular state for out-of-state incorporations after Delaware, attracts firms that have a large and significant likelihood of reporting financial results that later require restatement. Compared with Delaware and other states, restatement likelihoods for Nevada-incorporated firms are nearly double on an unconditional basis, and up to 40% higher when controlling for firm-level characteristics. Nevada attracts firms from states with relatively weak protections for managers and directors, and firms with strong existing contractual protections for these insiders. Our results suggest that firms favoring strong protections for insiders endogenously select Nevada as a corporate home, and these firms are prone to financial reporting failures. We also show that Nevada firms that restate lose a large amount of value in the year following the restatement, significantly more so than restating firms incorporated in other states. Our findings indicate that firms may self-select a legal system that matches their desired level of private-benefit consumption, and that Nevada competes by attracting firms with higher agency costs.

Number of Pages in PDF File: 55

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