Shareholder Litigation and Bank Risk

Does a decline in shareholder litigation enhance managers’ monitoring efforts by ensuring adequate firm risk management? We explore how state Universal Demand laws (which limit shareholder litigation as a mechanism to discipline managers, UD law hereafter), affects bank holding companies’ (BHCs) risk. Using a difference-in-differences analysis, we show that BHCs reduce their tail risk exposures after the implementation of the UD laws and that this is achieved by improving loan asset quality. Indeed, BHCs appear to apply stricter contract terms for syndicate loans to risky and opaque borrowers. We also show that UD law implementation leads to changes in BHC board composition by increasing the proportion of outside directors, the number of independent directors in audit committees, and the number of independent directors with financial expertise.