The reaction of firm ex ante cost of equity capital to the resolution of shareholder class action lawsuits

Existing research provides evidence that providers of capital (banks, public debt, and equity) all increase the expected return on securities after the initiation of a shareholder lawsuit. Many of these lawsuits are dismissed or settled with trivial monetary penalties, which suggests that an across-the-board permanent increase in the cost of capital is misguided. After estimating the probable outcome of a shareholder lawsuit using only information available at the time the shareholder lawsuit is filed, we study the resolution of shareholder lawsuits to determine if market participants adjust their expected return after a case is resolved. We find an increase (decrease) in the ex ante cost of equity capital when there is a surprise settlement (dismissal), which is consistent with an efficient market. Further, we present evidence consistent with equity market participants monitoring the progress of shareholder lawsuits prior to resolution. Overall, our results suggest that firm ex ante cost of equity capital only changes after the resolution of a shareholder lawsuit if the outcome of the case is different than initially predicted.