Firm-Level Litigation Risk: Measurement and Effects

Firms are exposed to litigation risk from various stakeholders, including investors, customers, and regulators, and prior research has shown that such risk shapes a range of corporate policies. In this study, we develop a simple and transparent measure of firm-level litigation risk by parsing SEC 10-K annual reports. This measure demonstrates strong predictability for lawsuits, even after controlling for firm characteristics, existing lawsuits, geographic factors, and various fixed effects, including firm fixed effects. This simple measure performs comparably to a more resource-intensive, AI-generated litigation risk measure. We further link our measure of litigation risk to a variety of corporate policies, including cash holdings, capital expenditures, R&D, and acquisitions, uncovering results consistent with the literature.