THE EFFECT OF RETRIBUTION ON SHAREHOLDER LITIGATION AND MANAGERS REPORTS

Shareholder litigation is important because it is costly and can influence firms reporting behavior. Prior research finds that attorneys incentives and specific firm characteristics drive shareholder litigation. In this study, I control for these known drivers in order to examine whether an additional behavioral factor, investor retribution, also drives shareholder litigation. Retribution theory suggests that investors will initiate litigation to punish managers for misreporting even when there is no financial incentive to do so. My study uses experimental markets to examine whether retribution plays a role in investors litigation decisions, and if this, in turn, affects managers reporting decisions. Consistent with economic theory, I find that when investors do not have an option to initiate litigation, managers frequently misreport and investors do not find their reports credible. Further, when investors have an option to initiate litigation and a financial incentive to do so (similar to current securities laws), misreporting decreases and the credibility of managers reports increases. However, inconsistent with economic theory but consistent with retribution theory, when investors have an option to initiate litigation but have no financial incentive to do so, misreporting decreases and the credibility of managers reports increases to approximately the same level as when investors have a financial incentive to initiate litigation. These findings have important implications for regulators and managers who need to accurately anticipate investors litigation decisions in order to make optimal policy and reporting decisions.