Does Media Coverage Cause Meritorious Shareholder Litigation? Evidence from the Stock Option Backdating Scandal

Our recent paper uses the Wall Street Journal’s coverage of the stock option backdating scandal to examine whether media coverage causes meritorious shareholder litigation. While the media has a prominent role in covering corporate scandals, it is unclear whether the media coverage itself causes any subsequent litigation because the underlying corporate misconduct and firm characteristics may cause both the litigation and attract media coverage. Thus, meritorious litigation may have eventually occurred even in the absence of media coverage. Evidence on the causal relation between media coverage and meritorious litigation is timely due to growing concerns about the precipitous decline in newspapers nationwide and whether it will result in a significant decrease in corporate accountability (Grieco 2020; Knight Foundation 2019). The findings further have a number of important implications for the media, firms, and others.

We predict that media coverage will increase the likelihood of meritorious litigation because such coverage may increase the expected payoff of such litigation to plaintiffs’ lawyers. Specifically, the expected payoff is a function of the settlement probability, expected settlement amount, and expected litigation costs, and media coverage may affect each of these components. That is, media coverage can provide new “expert witness” information or increase the credibility of existing information, increasing both the probability of settlement and expected settlement amount. Additionally, negative media coverage may contribute to an abnormal price decrease, which may increase the settlement probability by establishing loss causation and increase settlement amounts by increasing shareholder damages. Finally, media coverage may lower investigation costs. That is, plaintiffs’ lawyers may rely on experts cited by the media, and coordination costs may be lowered by making it easier to assemble a class of affected plaintiffs.

Importantly, because we can estimate the probability that a firm engaged in backdating with a high degree of confidence, we can compare firms identified as likely backdaters by the Wall Street Journal as part of their “Perfect Payday” series from November 2005 to December 2006 to similar firms that did not receive such media coverage that are similar in other relevant respects. The non-Wall Street Journal firms in our sample having similar backdating probabilities to firms reported on by the Wall Street Journal, there are no significant differences between the two groups of firms on the existence of related government investigations, litigation risk, size, and numerous other firm characteristics. Nonetheless, we find that being reported on by the Wall Street Journal dramatically increased the likelihood of litigation. Our inferences are robust to using a variety of econometric analyses, including instrumental variable analysis and a generalized difference-in-differences specification with firm- and quarter-fixed effects. For example, we find that being named by the Wall Street Journal increases the likelihood of a case filing in the same quarter by 45 percentage points.

We conduct a number of additional analyses to show a mechanism by which the Perfect Payday articles could have increased expected payoffs for plaintiffs’ lawyers, and we find that our results are due to the content of the coverage, rather than the coverage itself. First, we find a negative and economically meaningful abnormal market reaction to firms accused of backdating by the Wall Street Journal equal to an almost two percent decline on the date of the articles, which expands to around a six percent decline over the seven-day window centered on the article dates. Second, we examine a counterfactual where the Wall Street Journal provided an alternative depiction of firms unusual option grants—that is, the Wall Street Journal attributed stock option grants after the September 11, 2001 terrorist attacks to executives taking advantage of a national tragedy, rather than backdating. Despite these firms having comparable backdating probabilities to firms reported as backdating by the Wall Street Journal, we find that these firms were less likely to be sued for backdating. Thus, plaintiffs’ lawyers appear to defer to the Wall Street Journal’s characterization of whether unusual stock option grants represent legally dubious conduct by firms. Finally, we find that firms discussed in more detail by the Wall Street Journal were more likely to be sued than firms only briefly mentioned, which appears largely due to new information provided by the Wall Street Journal, rather than simply rebroadcasting existing information.

Our paper makes three primary contributions. First, combined with prior research on fraud detection by the media (e.g., Dyck et al. 2010; Miller 2006), our findings suggest that concerns that the decline in the news industry will result in less corporate accountability are valid. Absent the Wall Street Journal’s coverage, it is likely that many of the firms in our sample would have faced no adverse consequences. Second, we show that the media extends corporate accountability to a wider set of firms and for more technical allegations than previously assumed. Third, we contribute to research on the media’s role in the capital markets and demonstrate that the media plays an information role.

The full paper is available for download here.