Ritter & Welch (2002), in their review article, state "In our opinion, leaving money on the table appears to be a cost-ineffective way of avoiding lawsuits." This paper proposes an enriched litigation risk framework that can reconcile these Despite this recent support, some researchers Lowry & Shu (2002), however, take into account the endogeneity of initial returns and lawsuit incidence and find support for both an insurance and a deterrence effect as predicted by litigation risk theories. Underwriters concerned about lawsuits may attempt to hedge litigation risk by underpricing.ĭrake & Vetsuypens (1993), in the first empirical paper to study the effect of litigation risk, examine differences in initial returns between IPOs that are sued and those that are not and find no evidence that underpricing reduces the incidence of a 2 Given the inherent uncertainty of an IPO, and the potential reputational losses associated with litigation, issuers and 1 Section 11 of the Securities Act of 1933 gives investors the right to sue issuers and underwriters for declines in value below the offer price due to material
When proposed by Tinic (1988) and Hughes & Thakor (1992) as a potential explanation for underpricing in initial public offerings (IPOs), litigation risk seemed both intuitively plausible and economically relevant.
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