Managerial Liability and Corporate Innovation: Evidence from a Legal Shock

59 Pages Posted: 15 Nov 2017 Last revised: 20 Jun 2021

See all articles by Yuyan Guan

Yuyan Guan

Nanyang Business School, Nanyang Technological University

Liandong Zhang

Singapore Management University - School of Accountancy

Liu Zheng

City University of Hong Kong

Hong Zou

The University of Hong Kong - Faculty of Business and Economics

Date Written: 2017

Abstract

Despite a longstanding debate over the pros and cons of imposing legal liability on directors and officers (D&Os), there is limited evidence on how D&O liability affects corporate innovation. We study this question by exploiting Nevada’s 2001 corporate law change that dramatically lowered D&O legal liability and helped Nevada become the second most popular state for out-of-state incorporations. We find that firms incorporated in Nevada exhibit an increase in innovation outputs relative to matched control firms after the law change, particularly firms facing higher litigation risk or operating in more innovative industries. The results are driven mainly by exchange-listed firms that are subject to better governance than over-the-counter (OTC) listed firms. Lower D&O liability also enables firms to pursue more risky, but potentially more rewarding, explorative innovation. Therefore, although holding D&Os liable may be desirable overall, it also entails a cost by discouraging innovation in some firms. Our study has implications for how the litigation environment may influence sustainable growth via innovation.

Keywords: Innovation, Risk Taking, Legal Liability, Litigation Risk, Nevada

JEL Classification: G34, K41, O31

Suggested Citation

Guan, Yuyan and Zhang, Liandong and Zheng, Liu and Zou, Hong, Managerial Liability and Corporate Innovation: Evidence from a Legal Shock (2017). Singapore Management University School of Accountancy Research Paper No. 2021-130, Journal of Corporate Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3070160 or http://dx.doi.org/10.2139/ssrn.3070160

Yuyan Guan

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

Liandong Zhang (Contact Author)

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

HOME PAGE: http://accountancy.smu.edu.sg/faculty/profile/150531/Liandong-ZHANG

Liu Zheng

City University of Hong Kong ( email )

Kowloon Tong
Hong Kong

Hong Zou

The University of Hong Kong - Faculty of Business and Economics ( email )

China

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