Litigating Innovation: Evidence from Securities Class Action Lawsuits
Our paper provides novel evidence suggesting that a central pillar of the U.S. litigation and corporate governance system, securities class action lawsuits, acts as an implicit “tax” on valuable innovation. We propose a new perspective on this link between innovation and litigation, which we label the “valuable innovation hypothesis.” This hypothesis holds that low-quality lawsuits specifically target successful innovators, i.e., firms that have recently received economically valuable patents and are about to embark on implementing their valuable ideas, because such successful firms are attractive for lawyers to sue.
We find strong empirical support for the valuable innovation hypothesis. Using data from the Stanford Securities Class Action Clearinghouse (SCAC) on class action lawsuits filed against public U.S. companies between 1996 and 2011, and using the private economic value of a firm's newly granted patents as a measure of valuable innovation, we show that valuable corporate innovation increases the likelihood of being the target of a low-quality class action lawsuit. On top of making a lawsuit more likely, we find that valuable innovation is associated with greater losses to shareholders conditional on a low-quality class action lawsuit being filed. Our results are consistent with higher opportunity costs of managerial time and reputational capital, as well as greater use of optimistic forward-looking language by successful innovators, being among the channels through which successful innovators become attractive targets.
Combined, these findings imply that the expected costs of meritless class action lawsuits are particularly high for firms with the highest innovation output, and they have potentially important implications for understanding how securities class action litigation can affect the competitiveness of the U.S. economy.