Share Price Drops and Shareholder Litigation
Posted: 26 Apr 1998
Date Written: April 1996
Under SEC Rule 10b-5, shareholders can sue a corporation that they believe has materially misled them about the firm's prospects. Recent legislation calls for reform of the rules governing shareholder class action litigation. This paper examines volatility and market sensitivity for both sued and nonsued firms. The approach is different from that of earlier papers in several ways. First, rather than selecting an arbitrary period prior to the lawsuit filing date, we examine both the financial performance and new-release characteristics of sued firms during the alleged misleading information period (MIP) of the suit, that is, during the period in which investors allege the firm misled the market. Second, we divide the lawsuit sample into categories depending on the allegations in the suit and the proximity of the MIP to the disclosure that caused the suit. Third, sued and nonsued firm samples, are larger than those in earlier papers. Comparison group samples have also been broadened to include industry, size and past behavior of sued firms, and firms acquitted of the charges. We find that sued firms are more likely to experience episodes of very poor performance as the population of nonsued firms. Sued firms exhibit higher systematic risk than the population of nonsued firms. Prior to the alleged misleading information period, sued firms experience abnormal positive returns for about three years. However, during the misleading information period, sued firms experience significant negative abnormal return. Sued firms issue more positive news in the MIP than matched groups of nonsued firms. Finally, we find that settlement values are significantly positively related to the seriousness of allegations in the suit, the length of time during which the shareholders allege they were misled, and to the overly optimistic tone of announcements about the firm during this misleading information period.
JEL Classification: G12, G14, G18, K22
Suggested Citation: Suggested Citation