Securities Litigation Risk for Foreign Companies Listed in the US
Executive Summary — In the US, securities class action litigation provides investors with a mechanism to hold companies and managers accountable for violations of securities laws. This study examines the incidence of securities class action litigation against foreign companies listed in the US and the mechanism driving the litigation risk. Looking at more than 2,000 securities class action lawsuits between 1996 and 2010, the authors find that significant litigation risk does exist for foreign issuers, but at rates considerably lower than for US companies. The authors also identify potential factors in lower litigation rates: 1) transaction costs and 2) the lower rate of trigger events such as accounting restatements, missing management forecasts, or sharp drops in stock prices that are needed in a lawsuit context to allege intentional and wrong prior disclosures on the part of managers. This suggests that while the effective enforcement of securities laws is constrained by transaction costs, availability of high quality information (that reveals potential misconduct) can contribute to a well-functioning litigation market for foreign firms listed in the US. Key concepts include:
- Foreign firms listed in US are only half as likely to have a securities class action lawsuit as comparable US firms. This lower rate is economically meaningful.
- Transaction costs of pursuing litigation against foreign firms play a role. Firms in countries that are farther from the US, have weaker judicial efficiency in the home country or have a weaker track record of prior US. acquisitions are less likely to be targeted by plaintiff investors and attorneys.
- Once a lawsuit-triggering event like an accounting restatement, missing management guidance, or a sharp stock price decline occurs, there is no difference in the litigation rates between a foreign and comparable US firm
- Lower litigation risk for foreign firms implies that, relative to US firms, foreign firms will face less frequent pressure to improve disclosure quality and corporate governance or make other corrective actions following a lawsuit.
We study securities litigation risk faced by foreign firms listed on US exchanges. We find that US listed foreign companies experience securities class action lawsuits at about half the rate as do US firms with similar levels of ex ante litigation risk. The lower rate appears to be driven partly by higher transaction costs in uncovering and pursuing litigation against foreign firms. However, once a lawsuit-triggering event like an accounting restatement, missing management guidance, or a sharp stock price decline occurs, there is no difference in the litigation rates between a foreign and comparable US firm. This suggests that effective enforcement of securities laws is constrained by transaction costs, and the availability of high quality information that reveals potential misconduct is an important determinant of a well-functioning litigation market for foreign firms listed in the US.