Do Shareholders Gain from Their Right to Sue? Evidence from Federal Judge Turnover

Abstract

Shareholders' right to sue corporations and managers is a controversial investor protection mechanism that has an ambiguous impact on equity value. We use exogenous variation in federal courts' ideology, for instance due to a judge's death, as a quasi-natural experiment in which only some firms face a shock to shareholders' right to sue. This design allows us to establish that strengthening the right to sue causes an equity value loss. The value loss is observed for both high and low levels of pre-existing protection of shareholders' litigation rights, and is unlikely to stem from other types of litigation. Additional results indicate that the equity value loss can be caused by a deterioration of firms' information environment.

Keywords: shareholder litigation, lawsuits, federal courts, judicial ideology, corporate valuation, law and finance, takeover threat, investor protection, deterrence, governance

JEL Classification: G32, G34, G38