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Law and Corporate Governance

Paper Session

Sunday, Jan. 3, 2021 12:15 PM - 2:15 PM (EST)

Hosted By: American Finance Association
  • Chair: Tracy Wang, University of Minnesota

Do Shareholders Gain from Their Right to Sue? Evidence from Federal Judge Turnover

Stefano Cassella
,
Tilburg University
Antonino Rizzo
,
Nova School of Business and Economics

Abstract

Shareholders' right to sue corporations and managers for breach of securities laws is a controversial investor protection mechanism whose impact on equity value is unclear. Using exogenous variation in courts' ideology concerning the protection of outside shareholders vis-a-vis corporations, we establish that strengthening the right to sue causes equity value loss. The loss only partially stems from mechanisms proposed in prior literature, such as direct and indirect litigation costs. At the same time, stronger right to sue distorts managers' incentives toward corporate disclosure, triggering larger information asymmetries, higher cost of capital, and hence reduction in the value of equity.

Disloyal Managers and Shareholders’ Wealth

Eliezer Fich
,
Drexel University
Jarrad Harford
,
University of Washington
Anh Tran
,
University of London

Abstract

The prohibition against fiduciaries appropriating business opportunities from their companies is a fundamental part of the duty of loyalty, the expectation of which is integral to U.S. corporate governance. However, starting in 2000, several states, including Delaware, allowed boards to waive this duty. Exploiting the staggered passage of waiver laws, we show that this weakening of fiduciary duty has significantly decreased firms’ investment in innovation. Firms covered by waiver laws invest less in R&D, produce fewer and less valuable patents. Remaining innovation activities contribute less to firm value, a fact confirmed by the market reaction when firms reveal their curtailed internal growth opportunities by announcing acquisitions.

Inference with Cluster Imbalance: The Case of State Corporate Laws

Allen Hu
,
Yale University
Holger Spamann
,
Harvard University

Abstract

A workhorse research design identifies the effects of corporate governance by changes in state laws, clustering standard errors by state of incorporation. Asymptotic inference using these standard errors, however, dramatically understates false positives: in a typical specification, randomly generated placebo laws have 1/5/10\%-level significant estimated treatment effects 9/21/30\% of the time. This poor finite sample performance is due to unequal cluster sizes, especially Delaware's concentration of half of all incorporations. Bootstrap or permutation tests mostly fix the problem, common robustness checks less so. The placebo law approach can also be used to calculate power, which will be acceptably high only for substantial effect sizes.
Discussant(s)
Jonathan Karpoff
,
University of Washington
Isil Erel
,
Ohio State University
Todd Gormley
,
Washington University in St. Louis
JEL Classifications
  • G3 - Corporate Finance and Governance