Litigation Risk and Managerial Contracting: Evidence from Universal Demand Laws

How do firms refashion managerial incentives in response to regulations that curb litigation-risk and decrease external discipline? We use staggered passage of Universal Demand (UD) laws that insulate managers from derivative-lawsuits and could, thereby, exacerbate risk-related agency conflicts. Firms respond to UD-laws by increasing risk-taking incentives (vega), compensating for weaker external discipline and incentivizing valuable risky-investments. Incentive shifts are associated with firm governance, as indicated by institutional ownership, product market competition and CEO-power. Firms boosting vega experience greater innovation, more extreme outcomes and stronger market response to new product announcements. Our results help reconcile extant findings on effects of UD-laws.

Keywords: Universal Demand Law, Compensation, Litigation, Corporate Governance

JEL Classification: G34

Suggested Citation: Suggested Citation

Humphery-Jenner, Mark and Humphery-Jenner, Mark and Islam, Emdad and Nanda, Vikram K. and Rahman, Lubna, Litigation Risk and Managerial Contracting: Evidence from Universal Demand Laws (May 10, 2019). UNSW Business School Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=3574393 or http://dx.doi.org/10.2139/ssrn.3574393