Managerial liability and corporate innovation : Evidence from a legal shock

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

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Original languageEnglish
Article number102022
Journal / PublicationJournal of Corporate Finance
Volume69
Online published24 Jun 2021
Publication statusPublished - Aug 2021

Abstract

Despite a longstanding debate over the pros and cons of imposing legal liability on directors and officers (D&Os), there is limited evidence on how D&O liability affects corporate innovation. We study this question by exploiting Nevada's 2001 corporate law change that dramatically lowered D&O legal liability and helped Nevada become the second most popular state for out-of-state incorporations. We find that firms incorporated in Nevada exhibit an increase in innovation outputs relative to matched control firms after the law change, particularly firms facing higher litigation risk or operating in more innovative industries. The results are driven mainly by exchange-listed firms that are subject to better governance than over-the-counter (OTC) listed firms. Lower D&O liability also enables firms to pursue more risky, but potentially more rewarding, explorative innovation. Therefore, although holding D&Os liable may be desirable overall, it also entails a cost by discouraging innovation in some firms. Our study has implications for how the litigation environment may influence sustainable growth via innovation.

Research Area(s)

  • Innovation, Legal liability, Litigation risk, Nevada, Risk taking, Shareholder litigation