The Determinants Of 10b 5 Litigation Risk PDF Download

We examine securities class action lawsuits that are filed after single-day stock price declines of 10% or more. We decompose ex ante (pre-fall) litigation risk into the likelihood a corporation will experience a 10% fall and the likelihood of being sued after such a fall. We use previous research about stock return distributions and a model of law firm behavior to develop predictions about the effects of firm characteristics on these likelihoods. We estimate these relationships with logit regressions and use the results to quantify the effects of each variable on the likelihood of a 10% fall, the conditional likelihood of a suit being filed after such a fall, and ex ante litigation risk. We find that variables that enter into shareholder damage formulas, including an estimate of proportion of the firm's shares that traded during the past year, the firm's market capitalization, share price declines during the previous year and share price declines on the fall date, are major determinants of ex ante litigation risk. Variables that increase the likelihood of a 10% fall, such as stock return volatility, decrease the likelihood that a law firm will file a suit after a 10% fall. We also find that most of our results are generalizable to lawsuits that do not follow 10% falls. We examine the announcements that accompany those 10% falls that our results indicate are particularly likely to trigger lawsuits, and we find that the types of announcements that accompany falls that do and do not prompt litigation are similar.