Litigation Risk Management Through Corporate Payout Policy

Abstract

Firms significantly modify their payout policy in anticipation of future litigation costs. We examine a comprehensive sample of U.S. corporate lawsuits and find that firms facing significant litigation risk pay lower dividends, and in some cases omit dividends while distributing more cash through share repurchases. Litigation risk changes the distribution of payouts but not the total payout yield as the increase in share repurchases offsets the decrease in dividends. Cash-poor firms cut share repurchases when settlement costs are incurred. The results suggest that firms at higher risk of litigation increase their payout flexibility.

Keywords: Payout Policy, Risk Management, Litigation Risk, Financial Flexibility, Dividends, Share Repurchases

JEL Classification: G32, G35, K22, D81