Litigation risk, financial distress, and the use of subsidiaries

Using a unique hand-collected dataset on corporate subsidiaries and lawsuits, we examine the relationship between litigation risk and subsidiary usage by large U.S. corporations. We find that firms, in general, tend to have a large number of subsidiaries when exposed to high litigation risk. We find that this tendency is strong in firms with relatively low financial position, while it is less pronounced in firms with relatively high financial position. High severity litigation risk matters more than low severity litigation risk. The results are consistent with the predictions of theoretical models and suggest an efficient link between litigation risk and subsidiary usage.