Law departments can affect the market’s reaction when a class-action lawsuit is announced

Event studies look at how the stock market reacts to significant corporate occurrences. Legal events, such as regulatory approvals, IP decisions, competition rulings, and major litigation are factored in by traders (See my posts of May 4, 2005 about event studies, July 25, 2005 on litigation and share price, and Dec. 10, 2005 about Merck’s Vioxx liabilities.) In terms of major litigation, when a class action lawsuit filed against a company reaches investor awareness, publicly traded companies usually suffer a drop in share price, a loss of market capitalization (See my post of Dec. 20, 2005 about the possibility of a futures market.).

That loss can be huge, according to a report prepared by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research, as summarized in Exec. Legal Advisor, Sept./Oct. 2006 at 7. “The maximum dollar loss for all suits filed during the first six months of [2006] was $127 billion.” The term “maximum dollar loss” means the dollar value decrease in market capitalization when comparing its high during the class period to the capitalization on the trading day immediately after the class action is filed. Not all that loss can be attributed to the lawsuit’s filing, but at least some is, and therefore law departments and their ability to forestall or resolve litigation influence the market’s reaction (See my post of June 5, 2006 on the general counsel’s affect on share price.).

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