What’s the cost of bad press for a publicly traded company that gets sued by shareholders?
A new study from the Tippie College of Business suggests that stock prices drop about 2%, and the more media coverage a firm receives, the quicker the drop in price.
Dain Donelson, professor of accounting, analyzed the stock prices of companies that were sued by shareholders in securities class action lawsuits between 1998 and 2019. He then compared stock price changes of those lawsuits that received media coverage and those that did not.
He found that when media covered a lawsuit:
—The firm that was the target of the lawsuit saw an excess price drop of approximately 2 percentage points compared to those companies where the lawsuits were not covered in the media as investors sold shares in response to news of the lawsuit.
—The price drop began almost immediately after the lawsuit was reported by the media, often within 5 minutes of the story breaking.
—Market reactions increased with more original and/or detailed reporting.
Meanwhile, sued firms that received no media coverage also saw their stock price drop, but at a much slower rate, as investors had to learn about the lawsuits through other sources. Donelson said it took about two weeks for the price drop from those firms to match the decrease from the firms that received media coverage.
Donelson said readability also likely factors into the difference. Media reports are written in plain English and are relatively easy for investors to understand, while legal filings are complex and difficult to read for everyone except attorneys.
Prior research found that stock prices drop by 3-4% after a company gets sued, but this study puts the number closer to 2%.
Donelson said that while a 2% additional price drop is not a trivial amount, it’s not economically significant for companies with billion-dollar market capitalizations that are usually the subject of such lawsuits. In fact, most of those lawsuits are settled out of court and don’t even go to trial. Still, he said the circumstance presents an opportunity for investors to exploit if they were able to find out about lawsuits that aren’t covered by media before other investors.
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