Litigation Risk and Cost Behavior: Evidence from Derivative Lawsuits
66 Pages Posted: 18 Aug 2017 Last revised: 1 Jun 2018
Date Written: May 27, 2018
This study explores whether managers’ personal litigation risk impacts managerial empire building through the lens of their firms’ cost behavior. Exploiting the staggered adoption of universal demand (UD) laws at the state-level in the U.S., we find a significant decrease in Selling, General & Administrative (SG&A) cost elasticity and a significant increase in SG&A cost asymmetry after the exogenous decrease in managers’ personal litigation risk. These associations are not driven by the pre-adoption trend and are robust to a variety of changes in sample composition. In addition, we find that the effect of UD laws is more pronounced in firms: (1) with lower future value creation potential of SG&A costs; (2) with weaker corporate governance; (3) operating in less competitive product markets; (4) with higher information asymmetry; and (5) with lower ex ante litigation risk. Our findings highlight the importance of shareholders’ litigation rights in curbing managerial empire building and add to the agency explanation for cost behavior.
Keywords: Cost Asymmetry, Cost Structure, Managerial Empire Building, Shareholder Litigation, Universal Demand Laws
JEL Classification: M41, K22
Suggested Citation: Suggested Citation