Shareholder Litigation and Corporate Innovation

We investigate whether and to what extent shareholder litigation shapes corporate innovation by examining the staggered adoption of universal demand laws in 23 states from 1989 to 2005. These laws impose obstacles against shareholders filing derivative lawsuits, thereby significantly reducing managers’ litigation risk. Using a difference-in-differences design and a matched sample, we find that, following the passage of the laws, firms invested more in research and development, produced more patents in new technological classes and more patents based on new knowledge, generated more patents with significant impacts, and achieved higher patent value. Our findings suggest that the external pressure imposed by shareholder litigation discourages managers from engaging in explorative innovation activities. This paper was accepted by David Simchi-Levi, finance.