Growing Out of Trouble? Corporate Responses to Liability Risk,
Review of Financial Studies
This paper analyzes the importance of agency conflicts arising from managers' exposure to their firms' risk. In particular, we study how a typical firm responds to an exogenous increase in legal liability arising from its workers' exposure to newly identified carcinogens. We find that such firms, particularly those with weak balance sheets, tend to undertake aggressive growth through acquisitions. The acquired firms tend to be large, unrelated businesses with relatively high operating cash flows, recent growth, and total payouts. These deals are associated with high takeover premiums and negative abnormal returns. These findings support a managerial agency model: we find that firms with weak external governance, high management ownership, or low institutional ownership are most likely to grow. The results suggest that corporate governance can be particularly important when firms encounter a negative shock.