Authors: Virginia Sotiropoulou, Dimitris Tzelepis

Title: Litigation risk and cash holdings: Textual analysis of U.S. annual disclosures

Abstract

This paper attempts to examine the impact of litigious risk, as it is revealed in firms’ annual disclosures, on corporate financial policy. The main research question is whether managers hoard cash or decrease the amount of cash when the company faces legal risk.

Therefore, this paper attempts to link a major source of corporate risk (litigation risk) with one of the main decisions that managers have to take about the company’s financial strategy, the level of cash holdings. As a proxy of legal risk, litigious words that are included in annual reports are used. This index is measured with textual analysis and in specific, with the adoption of dictionary method introduced by Loughran and McDonald (2011). Thus, the impact of litigation risk on cash holdings strategy is examined under the spectrum of textual analysis, adopting an alternative measure of litigation risk that it has not been used in the relevant literature until now. The results of textual analysis are combined with financial data of U.S. firms. The findings of this study indicate that when litigation risk is increased, the level of firm’s cash holdings decreases.

Keywords: litigation risk, cash holdings, textual analysis

JEL classification codes: M41, G30