Implications of securities class actions for cost of equity capital

The purpose of this paper is to investigate the effects of class action litigation on firms' cost of equity capital.

The paper uses three different models to estimate the cost of equity capital. To separate the impact of lawsuit filings on the cost of equity capital from that of the revelation event, a sample of lawsuits with a long lag between the disclosure events and filing dates was analyzed. Also, a comparison group study was conducted to illustrate the distinct impact of a lawsuit filing on the defendant firm's cost of equity capital. Finally, a multivariate analysis was used to examine the factors that affect the magnitude of such impact.

The paper finds that filing of a class action lawsuit results in a significant increase in the defendant firm's cost of equity capital incremental to the effect of the disclosure event. Additionally, increases in the cost of equity capital after the lawsuit filings are higher when the lawsuits involve generally accepted accounting principle (GAAP) violation and have high merit, and when the defendant firms are small and have high leverage.

Findings in this paper suggest that the filing of a lawsuit brings new information to the market and is likely to increase the defendant firm's cost of equity capital by increasing the perceived risk in corporate governance, information asymmetry and operation.

This paper reveals securities class actions increase the defendant firms' cost of equity capital.