Litigation Risk and Managerial Contracting: Evidence from Universal Demand Laws
60 Pages Posted: 7 May 2020 Last revised: 14 Apr 2022
Date Written: May 10, 2019
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