Corporate Investment Under the Cloud of Litigation

We study the effect of legal risk on firms’ investment. Using legal risk measures based on the number of litigious words in SEC 10-K filings, we find legal risk reduces investment. Underlying mechanisms include both i) a financing channel, whereby legal risk reduces credit ratings, increases bank loan costs, and decreases borrowing, and ii) an attention channel, whereby legal risk consumes top-management’s attention. Accordingly, we find legal risk has negative effects on firms’ investment efficiency and stock performance. We address endogeneity concerns through a DiD analysis utilizing staggered adoptions of universal demand laws across states.

Keywords: Legal risk, Investment, SEC 10-K filing

JEL Classification: G30, G31, K20

Suggested Citation: Suggested Citation

Bennett, Benjamin and Milbourn, Todd T. and Wang, Zexi, Corporate Investment Under the Cloud of Litigation (September 11, 2018). Fisher College of Business Working Paper No. 2018-03-18, Charles A. Dice Center Working Paper No. 2018-18, Available at SSRN: https://ssrn.com/abstract=3247688 or http://dx.doi.org/10.2139/ssrn.3247688