Managerial liability and corporate innovation: Evidence from a legal shock

• Main Authors: WANG, Xin, XU, Yongxin, ZHANG, Liandong, ZHENG, Gaoping
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2021
• Subjects: D&O liability; legal liability; directors; officers; corporate innovation; Nevada corporate law; innovation outputs; litigation risk; innovative industries; governance; exchange-listed firms; over-the-counter listed firms; risky innovation; explorative innovation; sustainable growth; litigation environment; Accounting
• Online Access: https://ink.library.smu.edu.sg/soa_research/2006
• Institution: Singapore Management University

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.