Doctoral Dissertation Research in Economics: Corporate Governance: Effects on Shareholder Litigation and Directors and Officers Insurance

Southern Methodist University, Dallas TX

Investigators

Abstract

ABSTRACT Prop ID: SES-0452844 P I: Fomby, Thomas B. Organization: Southern Methodist University Title: Doctoral Dissertation Research in Economics: Corporate Governance: Effects on Shareholder Litigation and Directors and Officers Insurance This study contributes to understanding one of the oldest conflicts in corporate finance: the agency problem between shareholders and managers, which has significant implications for the efficiency of market-oriented economies. Shareholders cannot always observe the actions of the managers and the latter may not always act in the best interest of the shareholders. Therefore, shareholders have to design mechanisms to ensure proper behavior by the managers. Those mechanisms are generally implemented through proper corporate governance. The ultimate failure of corporate governance is when it is not able to resolve the grievances of shareholders with internal mechanisms and they have to resort to litigation. Theoretically, good governance should be associated with less shareholder litigation and bad governance should be associated with more litigation. But is that conjecture empirically true? This study addresses this question for the first time, using a comprehensive database of shareholder litigation in the US over the years and a corporate governance database. The question to be answered ultimately is whether better corporate governance results in less litigation and whether better governance is really the solution to the shareholders-managers agency problems. A related issue is the amount of insurance companies purchase to protect themselves from shareholder litigation. That study applies various dynamic panel data models to test several corporate insurance theories, which have not been tested in the past with US data. Another part of the study addresses the impact of filing securities lawsuits on the company's stock returns, employing event study and more advanced intervention methodology. Event study methodologies have not previously been applied to analyzing the impact of securities litigation on stock returns. There is an important distinction between this and other types of litigation, because shareholders may also be still owners of the company they are suing. If the lawsuit decreases firm value, are they really better off by filing a lawsuit? This is an important academic and practical question, given the prevalence of securities litigation in this country. Do securities lawsuits really create or destroy investor wealth? The study is expected to have an impact on practitioners, such as shareholders and managers, as it will reveal the true impact of securities lawsuits on company value. Knowing the negative impact, if confirmed, shareholders may be less likely to file lawsuits against companies they still own. Managers can better manage the impacts of such lawsuits. The issue of whether better governance results in lower probability of litigation will have an important impact on the academic literature, which has dealt with corporate agency problems for a long time. If it turns out that governance does not lead to less litigation, this will open many theoretical and empirical questions that may challenge existing theory and practice. Both studies have implications for the level of shareholder wealth and whether securities lawsuits ultimately increase or decrease that wealth. The support we are seeking through the current grant application is crucial to the successful completion of this research vis the two databases.