Litigation Risk and Cost Behavior: Evidence from Derivative Lawsuits

66 Pages Posted: 18 Aug 2017 Last revised: 1 Jun 2018

See all articles by Leye Li

Leye Li

UNSW Sydney

Gary S. Monroe

University of New South Wales (UNSW) - Australian School of Business

Jeffrey Coulton

UNSW Business School

Date Written: May 27, 2018

Abstract

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

Li, Leye and Monroe, Gary S. and Coulton, Jeffrey J., Litigation Risk and Cost Behavior: Evidence from Derivative Lawsuits (May 27, 2018). AAA 2018 Management Accounting Section Midyear Meeting, Available at SSRN: https://ssrn.com/abstract=3020842 or http://dx.doi.org/10.2139/ssrn.3020842

Leye Li (Contact Author)

UNSW Sydney ( email )

UNSW Sydney Australia
Sydeney, NSW 2052
Australia

HOME PAGE: http://www.business.unsw.edu.au/our-people/leye-leonard-li

Gary S. Monroe

University of New South Wales (UNSW) - Australian School of Business ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia
+61293856443 (Phone)

Jeffrey J. Coulton

UNSW Business School ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia
+61293855811 (Phone)
+93855925 (Fax)

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