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Managerial litigation risk and corporate investment efficiency

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Leonard Leye Li, Gary Monroe and Jeff Coulton discuss the effect of managerial litigation risk on corporate investment efficiency.

Image courtesy of interviewee. March 15, 2024

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The study investigates the impact of changes in managerial litigation risk, particularly due to the adoption of universal demand (UD) laws in certain U.S. states. These laws significantly restrict shareholders' ability to file derivative lawsuits against managers by requiring board approval, which diminishes managerial litigation risk.

The research aims to understand how this reduction affects capital investment decisions by managers, particularly concerning investment efficiency—essentially, whether managers are effectively allocating resources to projects. The hypotheses suggest that after the adoption of UD laws, firms may experience increased underinvestment (where managers avoid investing in profitable projects) and overinvestment (where they invest in value-diminishing projects).

The findings indicate that firms in states with UD laws show a significant decrease in investment efficiency post-adoption, with evidence of increased underinvestment and overinvestment depending on the firm's circumstances. This video video reduced efficiency is linked to managers taking on excessive risk, as they feel less constrained by the threat of litigation.

Ultimately, the study contributes to existing literature by highlighting the unintended negative consequences of legislation intended to protect managers, showing that such protection can harm shareholder wealth by resulting in inefficient investment decisions. The results underscore the importance of regulatory frameworks in influencing corporate governance and investment practices.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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In our study, what we looked at was the consequences

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of changes in managerial litigation risk.

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Now, these changes were brought about

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by changes in rules in some states in the US

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that govern how easy

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or how difficult it is for shareholders to sue managers

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in actions known as derivative lawsuits.

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So some states adopted what are known

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as universal demand laws.

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Not all states, just some states.

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Now, for states that adopted these universal demand laws,

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these laws made it very difficult for shareholders

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to bring a derivative lawsuit against managers.

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Almost impossible.

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'cause basically, the, the board would have

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to approve these derivative lawsuits.

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So, as a result, these universal demand laws have led

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to a reduction in managerial litigation risk, okay?

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Where managers can be sued by shareholders.

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So, we test whether this reduction in managerial litigation

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risk affected the way that

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managers made their capital investment decisions

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by looking at the effect

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of these laws on investment efficiencies.

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So what do we mean by investment efficiency?

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Well do managers over or under investing capital projects

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after the introduction of beauty laws.

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So, economic theory would say that when you have capital,

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you should invest until the marginal returns on

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new investments are zero.

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So when you overinvest, it means

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that managers might be investing in projects

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with negative net present values, so that

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decreases shareholder wealth,

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but could result in empire building for managers,

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if managers underinvest, that might indicate

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that they're not investing in projects

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with positive net present values,

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which would be value enhancing for shareholders.

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So that's the basic gist of our study.

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Our paper relates to a number of streams

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of prior literature.

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Um, first, it adds to the literature on the importance

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of securities laws

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and shareholder protection informing corporate

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investment decisions.

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So existing evidence on the effect of litigation risk,

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on corporate investment decisions as somewhat mixed

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on the one hand cross country studies have shown

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that higher litigation risks that are imposed

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by stricter legal environments

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that protect the shareholders' rights, they tend

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to mitigate agency problems

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and improve corporate investment decisions.

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That's from Janoff at Allen, the Journal

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of Financial Economics in 2008, as well

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as La Porter et al 2000 in the Journal

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of Financial Economics.

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Similarly, brown, et al, in their Journal of Finance paper,

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find that markets with stronger shareholder protection

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demonstrate higher r and d investment and innovation.

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But on the other hand,

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shareholder litigation often imposes direct

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and indirect costs on defendant managers,

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and it discourages managers from taking risks

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and experimenting with new ideas.

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This reduces the efficiency

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and effectiveness of corporate investment.

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And that's been shown by block at AL 92, kin 94

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and Shana 2014.

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Recent studies by Chew and Joo in 2021, financial Management

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and lineal in 2021, management Science.

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They provide supporting evidence that the adoption

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of UD laws is associated with more r

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and d investment, more higher quality patents,

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and more profitable corporate takeovers.

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The, the Chew and Z 2021 paper,

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they focus on corporate merger

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and acquisition decisions while Lin L focus on r

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and d expenditure and patent lodging.

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Now, by contrast,

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our paper focuses on the overall investment level

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of a company, including both capital

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and non-capital expenditures, conditional on the likelihood

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of underinvestment and overinvestment investment.

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Secondly, our study is related

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to the literature on the determinants

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of firm's investment efficiency.

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Now, previous research in this area largely focuses on the

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role of various aspects

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of financial reporting quality in mitigating information

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asymmetry that curbs sufficient corporate investment.

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These aspects include accrual, equality,

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and financial statement readability.

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That's from Bid al in the JAE

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and accounting conservatism Garcia, also in the JE

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and disclosure of internal control weaknesses.

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That's from Chang Al in the JAE.

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Now, our study focuses on managerial litigation risk.

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Now that's an external governance mechanism that is

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beyond a manager's control.

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So we provide evidence that the deterrence effect

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of litigation risk also plays an important role in

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discouraging self-dealing investment decisions.

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And finally, our findings,

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we think have important implications for regulatory regimes.

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So, LA Porter at Allen, their 1997 Journal of Finance paper

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suggest that among shareholders, various legal rights,

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their litigation rights provide minority shareholders

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with legal protections against potentially

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oppressive directors.

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So policy makers also view litigation rights

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as a necessary governance tool.

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So in 20 20 12, the USEC said, in, in light

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of the limited resources available to the SEC,

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private enforcement

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of federal securities law is a necessary tool

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to combat securities fraud.

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So in this sense, the results

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of our paper may help law setters better serve the interests

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of minority shareholders.

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Since managerial litigation risk has an impact on the

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efficiency of the use of corporate resources,

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and thus shareholder value

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Lawsuits in the United States are form

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of legal action brought, brought

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by shareholders on behalf of the corporation.

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So by nature, the di in a der lawsuit, a shareholder

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or a group of shareholder sue a third party or parties.

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Often the party is, the company's directors

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and officers, including their executives on

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behalf of the corporation.

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So the sue, the, the lawsuit is derivative in nature

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because the shareholder's rights to sue

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the managers is derived from the corporation's rights.

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Uh, so the corporation itself is a necessary party

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to file the suit.

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And the purpose of the lose lawsuit is

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to correct some governance, mistreatment of the company

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so that these lawsuits are typically filed when the

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shareholders believe that the company's management

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or the board of directors have filed in their fity duties

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and caused, caused some harms to the company's value.

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So this might include, some cases of fraud, some,

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misstatement, self-dealing, et cetera.

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So one of the most, famous diverse

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derivative lawsuit might be in 2006.

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Uh, the Apples executives were, were sued by the,

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by the shareholders on behalf of the company

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for their overpayment.

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And Steve Jobs was one of the, defendant as well.

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Um, and, to file a Ative lawsuit,

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the shareholders must typically meet a certain requirement,

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including holding a certain amount of shares,

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for a specific period.

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And they also need to prove that they have fairly

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represented the interest of the whole company,

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of all the shareholders, and that they have attempted

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to resolve the issue with the company's management

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or the board before filing the litigation.

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And if the litigation is successful, any recoveries

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or benefits or monetary benefits will go directly

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to the corporation instead of to the shareholders.

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So there's no monetary outcomes, or,

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or monetary benefits for the shareholders or the plaintiffs.

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Uh, all the benefits goes to the company.

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Uh, usually the company will have,

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undergo some reforms in the corporate,

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corporate dominance mechanisms after the share,

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after the litigation.

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Um, and the court will examine whether the,

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lawsuit serves the benefit of the company

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and the action must be beneficial, must be beneficial

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to the company's wellbeing overall.

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Um, and the, in this litigation process,

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there's a demand requirement, that is

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before filing a ative lawsuit.

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The shareholders may generally required to,

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make a formal demand on the corporation's board of directors

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to address the, the roundings alleged roundings,

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unless such a de such a demand is, seems

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to be futal.

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Um, however, after the, the Universal Demand Laws,

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so, so there's, so we know

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that in the public companies, most of the directors,

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they themselves are the executives.

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So they're usually also the defendant

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of the original lawsuit.

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So in many cases, in most cases, the board

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of directors, they will reject the demand requirement.

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And so the, the shareholders, they will find ways

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to circumvent the board of directors to file the lawsuit.

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However,

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after the passage of UD laws universal demand laws,

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the shareholders, they must,

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get the requirements from the board

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before they can file direct derivative lawsuit.

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Uh, this largely increased the difficulty

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of filing those ative lawsuit

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or even make it impossible in those states,

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a adopted states.

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So this is the background about ative lawsuit and the,

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and the universal demand law,

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and for the investment efficiency,

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as Gary has introduced, is the, is

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how efficiently the company

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or the managers of the company is using the corporate

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resources to generate more, return for the company.

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Um, so in, in theory, a perfect manager,

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they should invest until the marginal rate

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of return equals to zero.

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Uh, that means they need to invest into all the positive,

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PV projects until the marginal,

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marginal MPV of the next project is zero.

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Uh, however, in reality, managers they have,

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for example, moral has a problem.

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That means they represent themselves interest instead

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of representing the shareholder's interest.

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So they will either overinvest to build a,

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a bigger empire, or they also may, underinvest

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because of their slacks.

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And the second problem, in reality is,

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the information friction.

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That means the managers, they may not want

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to disclose all the information.

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So that's the outsiders.

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They will charge higher cost of capital for the company so

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that the company may not have sufficient fund

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to invest in all the, all the positive MPV problems,

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PO positive MPV projects,

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that will also leads to underinvestment.

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So our hypothesis is that

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after the PO passage of UD laws, it makes much difficult

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for the shareholders to file in, litigation,

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derivative lawsuits.

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And the ative lawsuits is one

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of the most important mechanisms for the shareholders

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to govern them or the, to monitor the managers.

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So there will be more moral hazard

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and, information friction problems,

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which will lead to less information efficiency.

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For the research design, we use the Avvo method.

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That means we use the past data,

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from all the public companies that with available data,

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from the US to,

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and use the regression model

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to address our research question

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and our main data sources from comp compute stat

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and comp compute stat is a very popular database in the

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study of, finance and accounting.

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It provides standardized North America

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and global financial statements data, as well as market data

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for over 80,000 active and inactive public companies.

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Uh, that's, whose financial statements

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are public available.

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So comp that they collect those financial statement datas

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and, compile their databases.

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Uh, we just collect those financial statement data from the

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compute compute stat to calculate,

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the investment efficiency variables.

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And we also rely on compute stat's, data on the,

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state of incorporation of those companies to identify,

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in which year the,

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the company's states have adopted the UD law.

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So, at the year of the adoption of UD Law,

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the company was affected by this change.

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So we just compare our,

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our regression model essentially compares the

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before period and after period.

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So before period is the company.

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Um, the firm years, that have not affected

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by the UD law and the

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after period is the companies who, who,

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are incorporated in those UD states

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after the adoption of UD law.

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Uh, and also we are comparing the affected companies versus

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non-affected companies.

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So affected companies.

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Are those companies who are incorporated in those ud

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in incorporating those UD states

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and the non-affected companies,

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are those companies incorporating other states?

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So, so it is essentially a difference in difference design,

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which means we compare the changes of investment efficiency,

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from

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before the UD period to the post UD period among the

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companies, incorporated in the UD states

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and, the companies in, in those non UD states.

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And, this, the benefit of this research design is

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that we control for all the other, microeconomic

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variables that happens, throughout time.

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Uh, and our findings support our hypothesis

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that compare to the companies in non UD states.

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The investment efficiency of the UD states,

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UD states companies decrease significantly

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after the adoption of UD laws.

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Our primary results are consistent

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with our first hypothesis

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that UD law adoption has a negative association

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with investment when a firm is prone to under invest.

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So we find that the adoption of UD laws is associated

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with more underinvestment.

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Now, in terms of the economic significance of the results,

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we find that among firms that are prone to underinvestment

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the value of investment for firms incorporated in states

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that adopt UD laws is on average about 28%

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lower than that of the control firms in our sample.

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Now, our results are also consistent

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with our second hypothesis that the adoption of UD laws

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increases investment,

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and when over investment is more likely to occur.

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So we find that the adoption

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of UD laws in this case is positively associated

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with overinvestment.

15:52.825 --> 15:55.285
For firms that are more prone to overinvestment,

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and again, in terms of the economic significance

15:58.265 --> 16:01.165
of our results, we find that for firms that are prone

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to overinvestment, the value of investment of firms

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that are incorporated in states

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that adopted UD laws is on average about 25% higher than

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that of the control firms in our sample.

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And we also document results that support our hypothesis

16:19.235 --> 16:22.725
that UD laws seem to induce managers

16:22.745 --> 16:25.205
to invest in more risky projects.

16:25.545 --> 16:28.365
And we kind of measure this by using the variability

16:28.705 --> 16:29.965
of a firm's earnings.

16:30.545 --> 16:34.045
So this suggests that excessive risk taking is a channel

16:34.045 --> 16:37.685
through which reduced litigation risk harms a firm's

16:37.685 --> 16:38.725
investment efficiency.

16:39.265 --> 16:41.765
In our study, what we looked at was a relationship

16:42.285 --> 16:44.085
between managerial litigation risk

16:44.545 --> 16:46.365
and corporate investment decisions.

16:47.265 --> 16:50.165
So in particular, we're concerned about the effect of

16:51.065 --> 16:52.925
the adoption of UD laws,

16:53.235 --> 16:55.925
universal demand laws on investment efficiency.

16:56.625 --> 17:01.485
And we look at this because often new laws have intended

17:01.825 --> 17:03.525
and unintended consequences.

17:04.865 --> 17:06.085
So what we found was

17:06.085 --> 17:09.045
that investment efficiency decreases significantly

17:09.305 --> 17:12.485
for the affected firms after the adoption of UD laws.

17:13.265 --> 17:15.605
So that's probably an unintended consequence

17:16.355 --> 17:17.965
legislators didn't anticipate.

17:18.905 --> 17:22.845
So what do we mean by investment efficiency decreased?

17:23.555 --> 17:26.965
Well, firms make less efficient investment decisions

17:27.295 --> 17:30.685
after the adoption of UD laws compared to

17:31.255 --> 17:35.565
investment decisions in for firms located in states

17:35.635 --> 17:37.085
that didn't have UD laws.

17:38.425 --> 17:40.005
Now, less investment investment,

17:40.475 --> 17:43.045
less efficient investment decisions is not a good

17:43.045 --> 17:44.365
outcome for shareholders.

17:45.705 --> 17:47.485
We also found that managers tend

17:47.485 --> 17:49.525
to increase corporate risk taking

17:49.695 --> 17:51.485
after the adoption of beauty loss.

17:52.745 --> 17:55.245
Now, we did a number of robustness tests,

17:56.025 --> 17:58.685
and we find that our samples are reduc robust

17:58.745 --> 18:00.845
to different components of investment

18:01.105 --> 18:03.845
and variations of sample composition.

18:04.985 --> 18:07.045
So what did we learn that was new?

18:07.815 --> 18:09.285
While our study contributes

18:09.285 --> 18:12.765
to understanding the economic consequences of a change

18:12.905 --> 18:15.565
or variation in managerial litigation risk.

18:16.705 --> 18:20.765
Now, previous research mainly focused on the importance

18:20.765 --> 18:23.765
of the disciplinary role of shareholder litigation risk.

18:24.615 --> 18:28.785
However, prior research hadn't examined direct effective

18:28.785 --> 18:31.865
litigation risk on investment efficiency,

18:31.995 --> 18:34.065
which is the focus of our study.

18:35.205 --> 18:37.825
And again, we found

18:38.375 --> 18:41.665
that firms make less efficient investment decisions

18:41.795 --> 18:44.585
after the adoption of universal demand loss.

18:45.605 --> 18:48.065
So our findings would add to loss.

18:48.165 --> 18:51.905
That's concerns that weak legal infrastructures

18:52.675 --> 18:55.425
might harm shareholders' interests

18:55.975 --> 18:59.425
because shareholders would be better served by firms making

19:00.855 --> 19:02.295
efficient investment decisions.

19:04.005 --> 19:07.145
Now, previous research has also focused on the role

19:07.165 --> 19:11.185
of financial reporting in enhancing investment decisions.

19:11.965 --> 19:13.625
So we extend that literature.

19:14.405 --> 19:15.985
So as noted by Jeff, earlier,

19:17.105 --> 19:19.985
previous research has looked at the relationship between

19:20.675 --> 19:25.145
investment efficiency in the quality of financial reporting,

19:26.125 --> 19:29.265
the strength or weakness of internal controls,

19:30.045 --> 19:33.305
and the readability of financial reports.

19:34.645 --> 19:39.105
Now, we extended the ture by exploiting this exogenous

19:39.625 --> 19:42.025
decrease in manager's litigation risk,

19:42.685 --> 19:44.105
and the focus on the effect

19:44.105 --> 19:47.425
of managerial settings on investment efficiency.

19:48.045 --> 19:49.345
We add to the literature

19:49.925 --> 19:54.905
by showing an unintended consequence of the introduction

19:54.905 --> 19:59.105
of universal demand laws in several states, that it can have

19:59.705 --> 20:03.945
a negative effect on shareholder wealth.

00:00 - In our study, what we looked at was the consequences of changes in managerial litigation risk. Now, these changes were brought about by changes in rules in some states in the US that govern how easy or how difficult it is for shareholders to sue managers

00:20 - in actions known as derivative lawsuits. So some states adopted what are known as universal demand laws. Not all states, just some states. Now, for states that adopted these universal demand laws, these laws made it very difficult for shareholders to bring a derivative lawsuit against managers. Almost impossible. 'cause basically, the, the board would have to approve these derivative lawsuits.

00:49 - So, as a result, these universal demand laws have led to a reduction in managerial litigation risk, okay? Where managers can be sued by shareholders. So, we test whether this reduction in managerial litigation risk affected the way that managers made their capital investment decisions by looking at the effect of these laws on investment efficiencies. So what do we mean by investment efficiency? Well do managers over or under investing capital projects

01:26 - after the introduction of beauty laws. So, economic theory would say that when you have capital, you should invest until the marginal returns on new investments are zero. So when you overinvest, it means that managers might be investing in projects with negative net present values, so that decreases shareholder wealth, but could result in empire building for managers, if managers underinvest, that might indicate

01:59 - that they're not investing in projects with positive net present values, which would be value enhancing for shareholders. So that's the basic gist of our study. Our paper relates to a number of streams of prior literature. first, it adds to the literature on the importance of securities laws and shareholder protection informing corporate investment decisions.

02:24 - So existing evidence on the effect of litigation risk, on corporate investment decisions as somewhat mixed on the one hand cross country studies have shown that higher litigation risks that are imposed by stricter legal environments that protect the shareholders' rights, they tend to mitigate agency problems and improve corporate investment decisions. That's from Janoff at Allen, the Journal of Financial Economics in 2008, as well

02:50 - as La Porter et al 2000 in the Journal of Financial Economics. Similarly, brown, et al, in their Journal of Finance paper, find that markets with stronger shareholder protection demonstrate higher r and d investment and innovation. But on the other hand, shareholder litigation often imposes direct and indirect costs on defendant managers, and it discourages managers from taking risks and experimenting with new ideas.

03:19 - This reduces the efficiency and effectiveness of corporate investment. And that's been shown by block at AL 92, kin 94 and Shana 2014. Recent studies by Chew and Joo in 2021, financial Management and lineal in 2021, management Science. They provide supporting evidence that the adoption of UD laws is associated with more r and d investment, more higher quality patents, and more profitable corporate takeovers.

03:46 - The, the Chew and Z 2021 paper, they focus on corporate merger and acquisition decisions while Lin L focus on r and d expenditure and patent lodging. Now, by contrast, our paper focuses on the overall investment level of a company, including both capital and non-capital expenditures, conditional on the likelihood of underinvestment and overinvestment investment. Secondly, our study is related

04:16 - to the literature on the determinants of firm's investment efficiency. Now, previous research in this area largely focuses on the role of various aspects of financial reporting quality in mitigating information asymmetry that curbs sufficient corporate investment. These aspects include accrual, equality, and financial statement readability. That's from Bid al in the JAE and accounting conservatism Garcia, also in the JE

04:45 - and disclosure of internal control weaknesses. That's from Chang Al in the JAE. Now, our study focuses on managerial litigation risk. Now that's an external governance mechanism that is beyond a manager's control. So we provide evidence that the deterrence effect of litigation risk also plays an important role in discouraging self-dealing investment decisions. And finally, our findings, we think have important implications for regulatory regimes.

05:15 - So, LA Porter at Allen, their 1997 Journal of Finance paper suggest that among shareholders, various legal rights, their litigation rights provide minority shareholders with legal protections against potentially oppressive directors. So policy makers also view litigation rights as a necessary governance tool. So in 20 20 12, the USEC said, in, in light of the limited resources available to the SEC, private enforcement

05:41 - of federal securities law is a necessary tool to combat securities fraud. So in this sense, the results of our paper may help law setters better serve the interests of minority shareholders. Since managerial litigation risk has an impact on the efficiency of the use of corporate resources, and thus shareholder value Lawsuits in the United States are form of legal action brought, brought

06:07 - by shareholders on behalf of the corporation. So by nature, the di in a der lawsuit, a shareholder or a group of shareholder sue a third party or parties. Often the party is, the company's directors and officers, including their executives on behalf of the corporation. So the sue, the, the lawsuit is derivative in nature because the shareholder's rights to sue the managers is derived from the corporation's rights. so the corporation itself is a necessary party

06:42 - to file the suit. And the purpose of the lose lawsuit is to correct some governance, mistreatment of the company so that these lawsuits are typically filed when the shareholders believe that the company's management or the board of directors have filed in their fity duties and caused, caused some harms to the company's value. So this might include, some cases of fraud, some, misstatement, self-dealing, et cetera. So one of the most, famous diverse

07:17 - derivative lawsuit might be in 2006. the Apples executives were, were sued by the, by the shareholders on behalf of the company for their overpayment. And Steve Jobs was one of the, defendant as well. and, to file a Ative lawsuit, the shareholders must typically meet a certain requirement, including holding a certain amount of shares, for a specific period. And they also need to prove that they have fairly

07:49 - represented the interest of the whole company, of all the shareholders, and that they have attempted to resolve the issue with the company's management or the board before filing the litigation. And if the litigation is successful, any recoveries or benefits or monetary benefits will go directly to the corporation instead of to the shareholders. So there's no monetary outcomes, or, or monetary benefits for the shareholders or the plaintiffs. all the benefits goes to the company.

08:19 - usually the company will have, undergo some reforms in the corporate, corporate dominance mechanisms after the share, after the litigation. and the court will examine whether the, lawsuit serves the benefit of the company and the action must be beneficial, must be beneficial to the company's wellbeing overall. and the, in this litigation process, there's a demand requirement, that is

08:51 - before filing a ative lawsuit. The shareholders may generally required to, make a formal demand on the corporation's board of directors to address the, the roundings alleged roundings, unless such a de such a demand is, seems to be futal. however, after the, the Universal Demand Laws, so, so there's, so we know that in the public companies, most of the directors, they themselves are the executives.

09:24 - So they're usually also the defendant of the original lawsuit. So in many cases, in most cases, the board of directors, they will reject the demand requirement. And so the, the shareholders, they will find ways to circumvent the board of directors to file the lawsuit. However, after the passage of UD laws universal demand laws, the shareholders, they must, get the requirements from the board

09:53 - before they can file direct derivative lawsuit. this largely increased the difficulty of filing those ative lawsuit or even make it impossible in those states, a adopted states. So this is the background about ative lawsuit and the, and the universal demand law, and for the investment efficiency, as Gary has introduced, is the, is how efficiently the company

10:19 - or the managers of the company is using the corporate resources to generate more, return for the company. so in, in theory, a perfect manager, they should invest until the marginal rate of return equals to zero. that means they need to invest into all the positive, PV projects until the marginal, marginal MPV of the next project is zero. however, in reality, managers they have, for example, moral has a problem.

10:54 - That means they represent themselves interest instead of representing the shareholder's interest. So they will either overinvest to build a, a bigger empire, or they also may, underinvest because of their slacks. And the second problem, in reality is, the information friction. That means the managers, they may not want to disclose all the information. So that's the outsiders.

11:21 - They will charge higher cost of capital for the company so that the company may not have sufficient fund to invest in all the, all the positive MPV problems, PO positive MPV projects, that will also leads to underinvestment. So our hypothesis is that after the PO passage of UD laws, it makes much difficult for the shareholders to file in, litigation, derivative lawsuits. And the ative lawsuits is one

11:50 - of the most important mechanisms for the shareholders to govern them or the, to monitor the managers. So there will be more moral hazard and, information friction problems, which will lead to less information efficiency. For the research design, we use the Avvo method. That means we use the past data, from all the public companies that with available data, from the US to, and use the regression model

12:19 - to address our research question and our main data sources from comp compute stat and comp compute stat is a very popular database in the study of, finance and accounting. It provides standardized North America and global financial statements data, as well as market data for over 80,000 active and inactive public companies. that's, whose financial statements are public available. So comp that they collect those financial statement datas

12:49 - and, compile their databases. we just collect those financial statement data from the compute compute stat to calculate, the investment efficiency variables. And we also rely on compute stat's, data on the, state of incorporation of those companies to identify, in which year the, the company's states have adopted the UD law. So, at the year of the adoption of UD Law, the company was affected by this change.

13:20 - So we just compare our, our regression model essentially compares the before period and after period. So before period is the company. the firm years, that have not affected by the UD law and the after period is the companies who, who, are incorporated in those UD states after the adoption of UD law. and also we are comparing the affected companies versus

13:49 - non-affected companies. So affected companies. Are those companies who are incorporated in those ud in incorporating those UD states and the non-affected companies, are those companies incorporating other states? So, so it is essentially a difference in difference design, which means we compare the changes of investment efficiency, from before the UD period to the post UD period among the

14:19 - companies, incorporated in the UD states and, the companies in, in those non UD states. And, this, the benefit of this research design is that we control for all the other, microeconomic variables that happens, throughout time. and our findings support our hypothesis that compare to the companies in non UD states. The investment efficiency of the UD states, UD states companies decrease significantly after the adoption of UD laws.

14:56 - Our primary results are consistent with our first hypothesis that UD law adoption has a negative association with investment when a firm is prone to under invest. So we find that the adoption of UD laws is associated with more underinvestment. Now, in terms of the economic significance of the results, we find that among firms that are prone to underinvestment the value of investment for firms incorporated in states that adopt UD laws is on average about 28%

15:29 - lower than that of the control firms in our sample. Now, our results are also consistent with our second hypothesis that the adoption of UD laws increases investment, and when over investment is more likely to occur. So we find that the adoption of UD laws in this case is positively associated with overinvestment. For firms that are more prone to overinvestment, and again, in terms of the economic significance

15:58 - of our results, we find that for firms that are prone to overinvestment, the value of investment of firms that are incorporated in states that adopted UD laws is on average about 25% higher than that of the control firms in our sample. And we also document results that support our hypothesis that UD laws seem to induce managers to invest in more risky projects. And we kind of measure this by using the variability of a firm's earnings.

16:30 - So this suggests that excessive risk taking is a channel through which reduced litigation risk harms a firm's investment efficiency. In our study, what we looked at was a relationship between managerial litigation risk and corporate investment decisions. So in particular, we're concerned about the effect of the adoption of UD laws, universal demand laws on investment efficiency. And we look at this because often new laws have intended

17:01 - and unintended consequences. So what we found was that investment efficiency decreases significantly for the affected firms after the adoption of UD laws. So that's probably an unintended consequence legislators didn't anticipate. So what do we mean by investment efficiency decreased? Well, firms make less efficient investment decisions after the adoption of UD laws compared to investment decisions in for firms located in states

17:35 - that didn't have UD laws. Now, less investment investment, less efficient investment decisions is not a good outcome for shareholders. We also found that managers tend to increase corporate risk taking after the adoption of beauty loss. Now, we did a number of robustness tests, and we find that our samples are reduc robust to different components of investment

18:01 - and variations of sample composition. So what did we learn that was new? While our study contributes to understanding the economic consequences of a change or variation in managerial litigation risk. Now, previous research mainly focused on the importance of the disciplinary role of shareholder litigation risk. However, prior research hadn't examined direct effective litigation risk on investment efficiency, which is the focus of our study.

18:35 - And again, we found that firms make less efficient investment decisions after the adoption of universal demand loss. So our findings would add to loss. That's concerns that weak legal infrastructures might harm shareholders' interests because shareholders would be better served by firms making efficient investment decisions. Now, previous research has also focused on the role of financial reporting in enhancing investment decisions.

19:11 - So we extend that literature. So as noted by Jeff, earlier, previous research has looked at the relationship between investment efficiency in the quality of financial reporting, the strength or weakness of internal controls, and the readability of financial reports. Now, we extended the ture by exploiting this exogenous decrease in manager's litigation risk, and the focus on the effect of managerial settings on investment efficiency.

19:48 - We add to the literature by showing an unintended consequence of the introduction of universal demand laws in several states, that it can have a negative effect on shareholder wealth.

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