How Judge Appointment Can Impact Firms

黃昊 | HUI, Kai Wai | LI, Reeyarn Zhiyang

Litigation can be a costly process for firms. As such, the question of how the risk of securities class action lawsuits affects corporate decisions has drawn a great amount of research interest in accounting and finance literature. To measure ex ante litigation risk, previous studies have generally used industry membership, either alone or in conjunction with firm characteristics, such as size, stock, turnover, and returns. The problem is that these measures are also likely to capture industry and firm characteristics that are not relevant to ex ante litigation risk.

To address this issue, Allen Huang, Kai Wai Hui, and Reeyarn Zhiyang Li proposed a new measure to better capture ex ante litigation risk by exploiting firms’ external litigation environment. The authors stated that the outcomes of securities law enforcement depend heavily on the judicial system. Political theory of judicial decision making argues that the material available to judges rarely provides sufficient clarity when it comes to resolving disputes. With this in mind, judges’ individual characteristics have been known to influence legal outcomes. Within this framework, the authors focused their attention on federal judge ideology. “It is documented in both legal and political science studies that ideology is among the most important of judges’ personal attributes influencing civil liberties and economic lawsuit outcomes,” the authors explain.

The authors use “the most widely adopted measure of judge ideology,” the appointing president’s political affiliation. Their study demonstrated that the political appointment of judges can have economic consequences for firms.

Empirically, the authors set out to measure judge ideology at the circuit court level. This is because circuit and district court judges are usually the final arbiters of securities class action lawsuits, and circuit court decisions have binding constraints over district courts within their jurisdictions. Interestingly, their study found that judges that were appointed by Democratic presidents, i.e., more liberal ones, tended to side with shareholders in securities class action litigation. Conversely, judges appointed by Republican presidents were more conservative, and were more likely to favour firms in their decisions. From this, the authors concluded that “firms have a higher litigation risk if they are located in a circuit with a greater proportion of judges appointed by Democratic presidents.”

To validate this measure and demonstrate its economic consequences, the authors conducted three sets of empirical tests.  From these tests, they find that lawsuits filed in more liberal circuits are less likely to be dismissed and are more likely to settle in larger amounts. They found strong evidence that judge ideology is economically meaningful in predicting securities class action lawsuit filings and that it improves upon ex ante litigation prediction models used in the current literature. They also found that the lawsuit filing rate increases after the appointment of liberal judges, and vice versa for conservative judges.

The authors add, “we use managers’ voluntary disclosure decisions as a specific economic problem and show that our new measure can provide new insights that litigation risk measures based on firm and industry characteristic cannot.” The implications of these findings are important for empirical research related to ex ante litigation risk attributable to legal systems and the economic decisions of firms.



Associate Dean (UG Programs), Associate Professor