Corporate Fraud and the Consequences of Securities Class Action Litigation

We analyze class action litigation as a corporate governance device. Firms that have lower internal governance standards and those with fewer external monitors are more likely to be indicted. Lawsuits announcements are salient information to the market, as firms, on average, lose 12.3% without a reversal up to three years following the first court date, which points at a substantial reputation loss. Indicted firms readjust their operations, meanwhile sophisticated investors decrease their positions. Stock market activity surges for firms suspected of fraud, and a conservative trading strategy yields significant returns over the subsequent period. Lawsuits also affect competitors both through competitive and contagion channels.