Abstract

Firms with agency problems are more vulnerable to litigation, i.e. they are more likely to be sued. The U.S. securities laws allow shareholders to file a lawsuit against a firm when they feel that their investment in firm was misappropriated or misproperly managed by the firm’s executives. This paper examines the link between shareholder litigation and various corporate governance practices. Focusing on seasoned firms, we employ a sample of 1613 sued firms and a matching sample of 1613 non-sued firms. We find that poor corporate governance mechanism, shorter CEO tenure, lower CEO salary, and lower incentive pay in the form of restricted shares increases the probability of litigation, holding constant a wide range of control variables. We further document that sued firms improve their governance practices after a lawsuit by increasing the proportion of outside members on the board and dissolving the CEO-chairmanship link. These findings support the view that corporate governance has an impact on litigation risk, and that litigation leads to governance changes, at least at the board level.