Shareholder Rights and Capital Structure: Evidence from Derivative Lawsuits
46 Pages Posted: 22 Jan 2020
Date Written: December 25, 2019
We examine how changes in shareholder rights influence firms’ capital structure. We exploit the staggered passage of Universal Demand (UD) laws in 23 US states over a twenty-year period as an exogenous decrease in shareholder rights. UD laws introduced a significant hurdle for shareholders to file a derivative lawsuit on behalf of the firm. Since litigation by shareholders is a major avenue for enforcing shareholder rights, the passage of UD laws reduces investor protection. Using a difference-in-differences design, we find a higher financial leverage for firms incorporated in states which passed a UD law compared to firms incorporated in states that have no UD law. We also find a lower likelihood of equity financing and a higher likelihood of debt financing following the passage of UD laws. For debt financing, we find that firms tend to use loans, instead of bonds, following the passage of a UD law. Examining the underlying mechanism, we find that the shift from equity to debt financing is attributable to a lower stock market liquidity, caused by more severe agency conflicts between shareholders and managers, which arise due to restrictions in shareholder rights.
Keywords: Universal Demand laws, shareholder rights, shareholder litigation, litigation risk, capital structure, financing decisions
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