A Model of Shareholder Litigation as a Determinant of a Firm's Financial Policies

Abstract

The option to file a lawsuit against an entrepreneur encourages shareholders to fund projects and to retain entrepreneurs. An entrepreneur, at risk of a lawsuit filing, may save cash as a precautionary measure. When cash accumulates and a lawsuit filing does not occur, an entrepreneur increases investment in hopes of superior future performance. But if future performance wanes notwithstanding, shareholders then file a lawsuit against their entrepreneur. When cash is limited, debt may act as an alternative precautionary measure against a lawsuit filing. In summary, shareholder litigation risk can increase cash, investment, and debt.