“ Does Shareholder Litigation Deter Insider Trading ? ” on

This paper examines the possible deterrent effect of actual shareholder litigation on insider trading behavior for both defendant firms and their industry peers. We construct a composite index to capture the strength of a lawsuit as reflected in its merits and the rigorousness of the litigation process. Using a large litigation sample from 1996 to 2009, we find a significant decrease in the intensity of the insider stock sales for defendant firms following lawsuits that score high in the composite strength index. Further analyses indicate that the decrease is mainly driven by the decline in opportunistic insider selling. We also find the decrease to be more pronounced when the defendant firm also reduces its earnings management following the litigation. Finally, we find a significant decrease in insider selling for industry peers of defendant firms following strong lawsuits. This paper provides the first evidence on the existence of and variations in the deterrent effect of class action lawsuits on insider trading.