Shareholder litigation and private benefits of control: evidence from derivative lawsuits

We examine the effects of derivative litigation risks on the value of private benefits of control. Quantifying the value of private benefits of control using the voting premiums from option prices, we find that the value of the voting premium significantly decreases after firms experience derivative lawsuits. To address endogeneity concerns, we exploit the staggered adoption of Universal Demand (UD) laws across 23 U.S. states from 1989 to 2005 to investigate whether and how the reduction in litigation risks affects the level of voting premium. The results show that the adoption of UD laws increases the value of voting premiums. Our DID results are robust to a battery of tests. We also find that the adoption of UD laws leads to a decrease in the value of cash holdings, an increase in CEO cash compensation, and a decrease in investment efficiency and these effects are more pronounced for dual-class firms. Overall, our findings suggest that shareholder litigation can effectively curb the managerial extraction of private benefits. It has important implications for managers, shareholders, and policymakers.