Shareholder Litigation Spillover and Strategic Disclosure
LAN Tianqi, CHEN Yunsen, ZHAO Ruirui, JIA Ning
School of Economics and Management, Tsinghua University; School of Accountancy, Central University of Finance and Economics; School of Economics and Management, Beijing University of Chemical Technology
Summary:
The effective functioning of capital markets hinges on the interplay between public and private enforcement mechanisms. In China, the regulatory framework is transitioning from a government-dominated public enforcement regime to a more diversified, multi-stakeholder governance system. Under this evolving structure, administrative sanctions by the China Securities Regulatory Commission (CSRC) and disclosure oversight by stock exchanges form the core of public enforcement, while shareholder litigation has emerged as a key channel for private enforcement, complementing public regulation and reinforcing market discipline. In recent years, shareholder litigation has gained increasing prominence in China's capital markets. As legal reforms accelerate, the volume of shareholder lawsuits has risen steadily, highlighting their potential role in promoting corporate transparency and accountability. However, due to a late start, limited institutional and practical maturity, private enforcement mechanisms remain relatively underdeveloped. Challenges such as the low frequency of lawsuits, ambiguous boundaries of liability, and a mismatch between litigation costs and expected compensation persist. These institutional limitations raise concerns that the actual enforcement effect of shareholder litigation may fall short of policy expectations. In this context, this paper adopts the perspective of “spillover effects” to systematically assess the external impact of shareholder litigation on the information disclosure behavior of other listed firms within the same industry, in order to evaluate its judicial deterrence and external governance effectiveness. We construct a novel hand-collected dataset of shareholder lawsuits involving A-share listed companies from 2006 to 2021 and employ a BERT-based financial large language model to conduct semantic analysis of annual report narratives. The analysis focuses on whether, and how, non-targeted peer firms strategically adjust the text content of their disclosures in response to litigation filed against other firms in the same industry. Our empirical findings show that peer firms significantly increase the positivity of narrative tone and reduce the disclosure of risk-related information in their annual reports following lawsuits in the industry. These effects are more pronounced when the litigation involves higher monetary claims or more plaintiffs. Strategic disclosure adjustments are particularly evident among firms with weak investor protection, heightened retail investor attention, and greater market pressure and volatility. In contrast, stronger monitoring by institutional investors tends to mitigate such behavior. Notably, this spillover effect is concentrated among firms with lower disclosure quality. We also observe that peer firms exhibit a significantly lower probability of issuing voluntary earnings forecasts and reduced readability in their annual reports. Further evidence suggests that while such strategic disclosure can lower the likelihood of being sued in the short term, it significantly undermines the information content of stock prices. These findings suggest that shareholder litigation exerts industry-level deterrent effects but may also induce unintended consequences such as defensive and potentially misleading disclosure practices. This study offers three main contributions. First, it provides new empirical evidence on the economic consequences of shareholder litigation in the Chinese institutional context, addressing the lack of systematic research on private enforcement in emerging markets. Second, it enhances methodological approaches in disclosure research by applying a BERT-based language model that is capable of capturing nuanced semantic shifts in corporate narratives—beyond what traditional dictionary-based methods can detect. Third, the findings yield policy implications for regulatory design. Policymakers should lower barriers for minority shareholders to seek legal recourse, enhance the enforceability and accountability of narrative disclosure rules, and improve investor education to increase market participants' ability to interpret corporate disclosure. A balanced and coordinated integration of public and private enforcement mechanisms is essential for building a transparent, resilient, and high-quality capital market.
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