Derivative Lawsuits as a Corporate Governance Mechanism: Empirical Evidence on Board Changes Surrounding Filings

48 Pages Posted: 5 Feb 2004

See all articles by Stephen P. Ferris

Stephen P. Ferris

University of Missouri at Columbia - Department of Finance

Robert M. Lawless

University of Illinois College of Law

Anil K. Makhija

Ohio State University (OSU) - Department of Finance

Date Written: September 2001

Abstract

Legal rights of investors have been recognized as an essential component of corporate governance. We assess the efficacy of these rights by an examination of the corporate governance effects of 215 shareholder derivative lawsuits filed in U.S. courts over the period, 1982-1994. We find significant negative stock price reactions at the filings of derivative lawsuits, with important cross-sectional variability in the cumulative abnormal returns (CARs). We observe that larger firms with higher R&D expenses, larger boards, and greater insider board representation tend to experience more negative CARs. We also find that the incidence of derivative suits is higher for firms with a greater likelihood of managerial agency problems. Most importantly, we find that derivative suits are associated with significant improvements in the boards of directors, which have been recognized as a critical aspect of corporate governance. We find that firms, whose managers lose derivative lawsuits, have smaller boards, a higher percentage of outside directors on their boards, and a greater departure rate among board directors in the periods following the filings of lawsuits. These findings suggest that shareholder derivative lawsuits have the intended benefits, affirming the useful role of U.S. courts in producing better corporate governance.

Keywords: shareholder derivative lawsuits, corporate governance effects

Suggested Citation

Ferris, Stephen P. and Lawless, Robert M. and Makhija, Anil K., Derivative Lawsuits as a Corporate Governance Mechanism: Empirical Evidence on Board Changes Surrounding Filings (September 2001). CORI Working Paper No. 01-03. Available at SSRN: https://ssrn.com/abstract=495583 or http://dx.doi.org/10.2139/ssrn.495583

Stephen P. Ferris (Contact Author)

University of Missouri at Columbia - Department of Finance ( email )

214 Middlebush Hall
Columbia, MO 65211
United States
573-882-6272 (Phone)
573-884-6296 (Fax)

Robert M. Lawless

University of Illinois College of Law ( email )

504 E. Pennsylvania Avenue
Champaign, IL 61820
United States

Anil K. Makhija

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-1899 (Phone)

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