Uncertainty of Legal Rights FROM THE PUBLISHER
If the outcome of a lawsuit depends solely on facts, law, and logic, a jury's decision should be predictable before it is announced. This study, however, finds evidence that the results of lawsuits are not predictable, implying that the decision process is influenced by some other undetermined factors accompanying the processing of facts, law, and logic.
While it is widely believed that lawsuit results are unpredictable, this is the first study to document the existence of financially meaningful uncertainty in litigation. It employs the event study methodology used in the econometrics of financial markets to determine whether events reveal new information, as contrasted with fully anticipated events. The markets react to filing of lawsuits in a generally negative way, but at filing time the reactions are no worse for firms that ultimately lose their suits than they are for those that eventually prevail. When court decision are announced, by contrast, there is a detectable positive reaction for winning firms and a negative reaction for losing firms
The implications for corporate finance are straightforward, as there is no evidence the expectations formed by markets are biased. Accordingly, the uncertainty inherent in lawsuits fits within existing models for decision making subject to uncertainty. There is no apparent reason why the risks inherent in litigation are systematic, so the financial impact of the risk can be eliminated by holding a diversified portfolio.
The deeper implication is for the capital budgeting decision, and indeed for the notion of designing one's activities within the framework of the law. By the time a jury verdict is announced, all the information on which it ostensibly is based has been publicly revealed in the course of the trial, and hence should be fully reflected in the prices of the litigating firms' shares. Yet the prices change when the result is announced. This suggests that the decision is not the mere processing of information, but rather contains an immeasurable or stochastic component as well."
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