The Influence of Major Lawsuits on Common Stock Returns

By Gratto, Clarence H.; Thatcher, John G. et al. | Akron Business and Economic Review, Spring 1990 | Go to article overview

The Influence of Major Lawsuits on Common Stock Returns


Gratto, Clarence H., Thatcher, John G., Thatcher, Janet S., Akron Business and Economic Review


The Influence Of Major Lawsuits On Common Stock Returns(*)

The purpose of this paper is to measure the impact on the price of a firm's common stock of the announcement or settlement of a major lawsuit against the firm. There are several reasons why such a study is important. First, the announcement or the settlement of a lawsuit against a firm is a common occurrence that is reported in the public press, and thus it constitutes readily available public information. Sometimes the dollar amount of the lawsuit represents a significant proportion of a firm's total assets. Given these facts, there is reason to believe that the announcement of such suits will represent relevant information for the pricing of common stock, and yet, to our knowledge, with the exception of the work by Jarrell[9], the impact of this type of information on stock market returns has not been studied.(1) Little is known about whether the market is efficient with respect to this type of information and thus reacts quickly and in an unbiased way.

Second, unlike the case with many studies of the impact on the stock market of the announcement of various types of information, announcements concerning lawsuits carry with them publicly stated dollar costs that should be related to the economic relevance of the information announcement. This permits one to study the relationship between the magnitude of the market's reaction and the size of the suit and to detect any bias in the size of the market's reaction.

Third, this form of information also permits one to determine the extent to which the market can accurately anticipate the announcement of a lawsuit or the direction of the verdict in a suit. In many cases, information concerning the impending announcement of a suit or about the progress of an ongoing suit may be leaked to the market. It is an interesting question to determine how far in advance the market can anticipate information concerning lawsuits.

Finally, for some types of suits it is unlikely that the market or the defendant in the suit will be aware of the suit before it is publicly announced. For these types of suits, any dramatic movements in the price of the stock may be associated with trading by insiders in advance of the announcement of the suit. (For evidence of insider trading in advance of a merger announcement, see Keown and Pinkerton[10]).

LAWSUIT DATA

The data set was originally collected by hand from articles that appeared in The Wall Street Journal over a period of years by one of the authors. At the time, lawsuits were selected from different types of cases based on their interesting legal characteristics for use as case material in a business law course. Only later was it realized that this data could be used to study the previously unstudied question of the impact of lawsuits on stock returns. In preparing the sample for use in this stock return study, twelve firms were eliminated because of the unavailability of a full complement of stock return data in the Center for Research in Security Prices (CRSP) Daily Stock Return File. Thirty-seven of these companies were eliminated because either the dollar magnitude of the suit was less than .1% of the total assets of the firm or the suit was withdrawn very shortly after it was filed. Thus, the working data set consists of 78 companies.(2) The earliest suit in the sample occurred in April, 1969, and the most recent suit occurred in August, 1984. Over 70% of the suits in the sample occurred since 1978.

Two types of announcement dates are determined by screening The Wall Street Journal Index. The "filing data" will refer to the date that the first announcement appeared in The Wall Street Journal that a suit involving a particular firm had been filed. At that date, a firm is designated as either the defendant or plaintiff in the suit. The "settlement date" will refer to the date that the first announcement appeared in The Wall Street Journal that a particular existing suit had been settled or a verdict had been rendered. …

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