Three essays on the legal environment, corporate policy and governance
This dissertation consists of three essays on the legal environment, corporate policy and corporate governance. The dissertation research seeks to contribute to a new understanding of the relationship between the legal environment, corporate behavior and corporate governance. In the first essay, we use a unique hand-collected dataset on corporate subsidiaries and lawsuits to examine the relationship between litigation risk and subsidiary usage by large U.S. corporations. We find that firms, in general, tend to have a large number of subsidiaries when exposed to high litigation risk. Dividing the sample into financially distressed and financially healthy sub-samples, we find that financially distressed firms tend to have a large number of subsidiaries when exposed to high litigation risk, while this tendency is less pronounced in financially healthy firms. High severity litigation risk matters more than low severity litigation risk. The results are consistent with the prediction of theoretical models. Taken together, they bring to light an efficient link between litigation risk and subsidiary usage. The second essay empirically examines the relationship between litigation risk and key financial and investment policy choices. We use a unique hand-collected database on corporate lawsuits as a proxy to measure litigation risk. The key financial and investment policies we investigate include: the levels of financial leverage, cash holdings, and capital expenditures. After controlling for other determinants of corporate financial and investment policies, we find a negative relationship between litigation risk and financial leverage. We also find a positive relationship between the level of cash holdings and securities and intellectual property litigation. In addition, we document a negative relationship between the level of cash holdings and high severity litigation risk in general, and government contracts, corporate governance, and employment and labor litigation, in particular. Furthermore, we find a positive relationship between litigation risk and the level of capital expenditures. Partitioning the sample into unified and parent-subsidiary firms, we find that relative to high litigation risk firms with a unified corporate structure, high litigation risk firms with parent-subsidiary structures have significantly higher levels of financial leverage and cash holdings, and lower level of capital expenditures. Thus, corporate organizational form appears to be a clear substitute for financial policy in responding to litigation risk. Taken together, these results highlight a link between litigation risk and corporate financial and investment policy choices. In Essay three, we examine the effects of board structure on corporate litigation. Using a unique hand-collected dataset on corporate lawsuits and the 2002 NYSE/NASDAQ exchange listing requirements on board independence as an exogenous shock, with the difference-in-difference methodology, we empirically examine how an increase in the percentage of independent directors on boards affects a wide variety of corporate litigation. We find that an exogenous increase in the percentage of independent directors on a board is associated with a significant decrease in corporate litigation. In addition, the results are stronger in industries where the exposure to the various types of corporate litigation is greater. These findings provide evidence of the effective monitoring role of independent directors.