Following the political theory of judicial decision-making, our paper proposes a parsimonious ex-ante litigation risk measure: federal judge ideology. We find that judge ideology complements existing measures of litigation risks based on industry membership and firm characteristics, and provides incremental explanatory power in predicting litigation occurrence and outcomes. Firms in more liberal circuits are more likely to be sued in securities class-action lawsuits. This effect is stronger for firms with more sophisticated shareholders and higher expected litigation payoffs. Next, we show that lawsuits filed in more liberal circuits are less likely to be dismissed and result in larger settlements. We further validate the measure using judge appointments and the U.S. Supreme Court’s ruling in the Tellabs case. Finally, using the new measure, we document that litigation risk deters managers from providing long-term earnings guidance, which existing measures cannot show.

Your participation is warmly welcomed!