The Impact of Shareholder Litigation Risk on Equity Incentives: Evidence from a Natural Experiment

Posted: 19 Jan 2018

See all articles by Jingyu Yang

Jingyu Yang

City University of Hong Kong

Yangxin Yu

City University of Hong Kong

Liu Zheng

City University of Hong Kong

Date Written: January 18, 2018

Abstract

While prior studies generally support that equity-based compensation induces CEOs to manipulate financial reporting, there is little direct empirical evidence on how concerns regarding financial misreporting affect compensation design. Exploiting the exogenous reduction in litigation threat brought about by a 1999 ruling of the U.S. Ninth Circuit Court of Appeals, we examine how the weakened litigation environment affected CEOs’ compensation design. Consistent with the theoretical prediction that concerns regarding misreporting prevent companies from providing more powerful incentive pay that is otherwise optimal, we find that firms headquartered in Ninth Circuit Court states decreased CEOs’ equity portfolio vega after the ruling. We also show that the reduction was more pronounced for firms with higher litigation risk and for firms with lower institutional ownership.

Keywords: Ninth Circuit Court ruling; Litigation risk; CEO incentives; Misreporting

JEL Classification: J33, K22, M52

Suggested Citation

Yang, Jingyu and Yu, Yangxin and Zheng, Liu, The Impact of Shareholder Litigation Risk on Equity Incentives: Evidence from a Natural Experiment (January 18, 2018). Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=3104687 or http://dx.doi.org/10.2139/ssrn.3104687

Jingyu Yang

City University of Hong Kong ( email )

Hong Kong

Yangxin Yu

City University of Hong Kong ( email )

Hong Kong

Liu Zheng (Contact Author)

City University of Hong Kong ( email )

Kowloon Tong
Hong Kong

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