Contrast disputes represent a common source of liability for firms, seen by many as the cost of doing business. Tort cases are another risk area, generating loss of profits, loss of reputation, loss of competitive advantage, and other types of losses. Your chances of getting involved in a court case depend solely on your exposure. For instance, if you started your business with a physical location or opened up a brick-and-mortar store after years of being in business online, you could get sued by someone who slips, trips, and falls on your front step. Lawsuits against small businesses are more common, especially when monetary damages are involved.
There’s no upside to corporate litigation, meaning that no matter what side wins, everyone loses out on the conflict. Solicitor fees add up quickly, not to mention the time, resources, and stress can take an emotional toll. Regardless of how you perceive a lawsuit, it’s not pretty. Even if litigation has always been present in the corporate environment, it’s recently evolved into a chief source of risk to the firm. Better management monitoring and more robust corporate governance can reduce the risk of being sued. You owe it to yourself and your hard work to protect your organisation and assets.
What Happens When Your Business Gets Sued?
Not only is litigation very expensive, but it also demands a considerable portion of your time and attention. You could find yourself in the middle of a lawsuit for various reasons. Try to imagine the following situation – in the warehouse, your workers often lift heavy items. Due to the lack of training and safety equipment, your firm can face a lawsuit and an investigation into the reason for the accident. Employees considering litigation will reach out to an experienced solicitor who knows the law inside out. Any victim can initiate a civil case. The outcome of the legal action will impact your reputation; a stigma can follow your business around for years.
Being in a court case can have profound effects on the financial health of your organisation, which is why you must make an informed decision about how to respond to the accusations being made against your business. A lawsuit has direct costs with large negative effects on cash holdings, profitability, and firm value, to name a few. Direct costs include the costs of solicitor fees, litigation costs, and the settlement or verdict payout. Some of the expenses are absorbed by insurance (most businesses must have employer’s liability insurance). Besides settlement disbursements and solicitor’s fees, organisations incur indirect litigation costs, which have a stronger effect on shareholder and debtholder value, such as loss of credibility.
The Stock Market Reaction to Corporate Lawsuits
Litigation against firms has existed for as long as businesses have competed. Irrespective of who the claimant is and whether or not the actions stem from civil or criminal law, the stock market reacts to the lawsuit. To be more precise, the market adjusts the firm’s stock price for the effect of litigation on profitability. In the month following the lawsuit, the organisation’s stock price declines significantly, which is attributable to reputation costs and the expectation of court restrictions on business practices. Surprisingly, organisations that settle litigation tend to be punished by the stock market. The popularity of alternative dispute resolution has prompted many firms to avoid disclosure, not to mention expensive litigation, yet the stock price experiences a negative return when the lawsuit is dismissed.
A Lawsuit Can Have a Deep and Lasting Impact on Corporate Behaviour
As far as business is concerned, litigation can have a negative impact, even if that’s not the intention. Paying damages or following a court order might seem like the end of the world, but it isn’t the only consequence you’ll face if your firm is sued. Litigation can have an effect on corporate behaviour, decisions, and outcomes. In what follows, we’ll shed some light on these matters:
- Equity issuance and IPO under-pricing – Shareholders have the right to sue a firm going public directly via a lawsuit or indirectly via a derivative lawsuit for material misstatements or omissions. Case outcomes are less favourable for defendants in IPO cases. A firm that under-prices its IPO has a decreased likelihood of being sued.
- Cost of capital – Because of its direct and indirect costs, litigation impacts the cost of capital, leading to increased risk-taking and more severe insider expropriation. What is more, the firm sustains a higher interest on its bank loan. When the organisation is more protected due to limited liability, it leverages higher credit ratings.
- Corporate financial policies – Financial policies are associated with the raising and use of funds. Corporate managers often modify financial policies to handle litigation. In other words, they increase their cash holdings in anticipation of lawsuits and reduce corporate investments.
- Financial reporting – Early financial disclosure enhances a firm’s legal exposure. The claimant is less likely to sue, or they’re forced to accept a lower settlement. Managerial ability and litigation risk go hand in hand; not everyone engages in opportunistic financial reporting.
- Corporate governance – Turnover among executives and directors isn’t uncommon in firms involved in a court case, especially if they’re guilty of financial misrepresentation. Equally, the CEO might suffer a reduction in compensation or be dismissed.
- Insider trading – Litigation deters insider trading, eroding investors’ confidence in the fairness and integrity of financial markets. To be more exact, it reduces the frequency and profitability of opportunistic trades. The threat of lawsuits plays a central role in deterring insider trading.
Disputes are part of the complex and volatile business environment. Litigation is a burden to any organisation, regardless of whether it’s the claimant or the defendant, often consuming internal resources and management attention. The collaborative approach between the legal department and the financial department can sometimes help address litigation effectively. Due to its effects on the firm’s activities, the lawsuit impacts finance, management, accounting, and economics. The good news is that measures can be taken to prevent litigation, such as understanding legal terminology, hiring a competent solicitor, and clearly communicating with employees.