Stock market signals and consequences of securities class actions lawsuits: a microstructure perspective

We perform a microstructure analysis of trading activities pre- and post-class period end-dates of securities class action lawsuits. We posit that these events are likely to significantly impact the spreads of affected firms, in addition to the well documented market capitalization loss that spurs the legal action. We detect neither meaningful widening of spreads nor change in put-call ratios ahead of the class period end-date, suggesting no microstructure or option open interest signal of the upcoming event. However, we present strong evidence of a significant degradation in market quality post the class period end-date based on widening spreads lasting for at least 60 trading days. We also document a trading volume spike and share price decline around the event date. Our research shows the impact on shareholders extends beyond the capitalization loss through wider spreads for defendant firms, while the same is not true for a control sample.