Under SEC Rule 10b-5, shareholders can sue a corporation that they believe; has materially misled them about the firm's prospects. Recent legislation; calls for reform of the rules governing shareholder class action; litigation. Writers for the business press and experts testifying before; the US Congress have argued that such litigation is largely frivolous in; that attorneys target firms with highly volatile stock return histories,; and litigated price drops are caused by return sensitivity to; contemporaneous market movements. Further, they argue that the legal; structure surrounding shareholder litigation produces excessive; settlements based on the target firms' fear of large jury verdicts.;
This paper examines volatility and market sensitivity for both sued and; nonsued firms. The approach is different from that of earlier papers in; several ways. First, rather than selecting an arbitrary period prior to; the lawsuit filing date, we examine both the financial performance and; news-release characteristics of sued firms during the alleged misleading; information period (MIP) of the suit: that is, during the period in which; investors allege the firm misled the market. Second, we divide the lawsuit; sample into categories depending on the allegations in the suit and the; proximity of the MIP to the disclosure that caused the suit. Third, sued; and nonsued firm samples are larger than those in earlier papers; for; example, our sued firm sample includes 491 observations. Comparison group; samples have also been broadened to include industry, size, past behavior; of sued firms, and firms acquitted of the charges.;
We find that sued firms are more likely to experience episodes of very; poor price performance than the population of nonsued firms. Sued firms; exhibit higher systematic risk than the population of nonsued firms. Prior; to the alleged misleading information period, sued firms experience; abnormal positive returns for about 3 years. However, during the; misleading information period, sued firms experience significant negative; abnormal return. Sued firms issue more positive news in the MIP than; matched groups of nonsued firms. Finally, we find that settlement values; are significantly positively related to the seriousness of allegations in; the suit, the length of time during which the shareholders allege they; were misled, and to the overly optimistic tone of announcements about the; firm during this misleading information period. © 1997 John Wiley & Sons,; Ltd.