This study examines the effect of securities litigation risk on public bond and private loan contract design. Judge ideology, as a proxy for litigation risk, is more exogenous than other proxies used in previous literature. I find that federal judge ideology affects the firm’s access to public debt market, with firms located in more liberal circuits (e.g., higher expected litigation risk) are more likely to borrow on public debt market rather than private debt market. I find that both bond yield spreads and loan spreads are lower for firms located in more liberal circuits. This effect is larger for firms with higher ex ante information asymmetry, consistent with the argument that the securities litigation risk attenuates the adverse effect of information asymmetry in both public and pri...[ Read more ]

This study examines the effect of securities litigation risk on public bond and private loan contract design. Judge ideology, as a proxy for litigation risk, is more exogenous than other proxies used in previous literature. I find that federal judge ideology affects the firm’s access to public debt market, with firms located in more liberal circuits (e.g., higher expected litigation risk) are more likely to borrow on public debt market rather than private debt market. I find that both bond yield spreads and loan spreads are lower for firms located in more liberal circuits. This effect is larger for firms with higher ex ante information asymmetry, consistent with the argument that the securities litigation risk attenuates the adverse effect of information asymmetry in both public and private debt contracting. For private loans, I find that firms located in more liberal circuits obtain less stringent covenants in contracts and this effect is stronger for firms with a higher ex ante default risk. Overall, my results suggest that borrowers located in more liberal circuits obtain more favorable terms in both public and private debt market.