Deanna Lee
Arizona State University
Abstract: I examine whether financial incentives such as the desire to smooth income, to take a big bath, to lower the firms cost of capital, or to avoid possible debt covenant violations, impact managements decision about the timing of litigation settlement. I also test whether managers pay a premium to settle lawsuits early or late. To test the relationship between the length of lawsuits and financial incentives, I develop a hazard model. The results in the study are broadly consistent with the hypotheses developed. Tests of the duration model show that the length of the duration of lawsuits is significantly related to abnormal earnings levels, the firms need to issue additional capital, and to high levels of debt-to-equity ratios. These results suggest that financial numbers and incentives play a role in managements decision to settle litigation. Further tests show that managers tend to settle lawsuits in the fourth fiscal quarter consistent with managers waiting until the end of the period to settle so that they know how much they are above or below their earnings targets. Finally, the results suggest that managers who settle early pay a premium.
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