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Shareholder Litigation and Changes in Disclosure Behavior

By Harvard Law School Program on Corporate Governance

(Editor?s note: This post comes to us from Jonathan Rogers and Andrew Van Buskirk at the University of Chicago Graduate School of Business. Their paper was recently accepted for publication in the Journal of Accounting and Economics)

While the deterrent function of private litigation has been studied in some detail, we investigate the existence of another potential benefit of securities litigation: a change in the conduct of the firms involved in private litigation. Specifically, we examine changes in the disclosure behavior of firms involved in 827 disclosure-related class-action securities litigation cases filed between 1996 and 2005. Prior studies have investigated how proxies for the threat of private securities litigation affect corporate disclosure behavior, but little is known about the behavioral changes of companies that are actually sued.

We find no evidence that the firms in our sample respond to the litigation event by increasing or improving their disclosures to investors. Rather, we find consistent evidence that firms reduce the level of information provided post-litigation. This reduction takes many forms. The probability of a firm hosting an earnings-related conference call or issuing an earnings forecast is lower following litigation. When firms choose to issue earnings forecasts, those forecasts are issued for shorter horizons and are less likely to be quantitative. When quantitative forecasts are issued, these forecasts are less specific (i.e., wider range estimates). We also find an increase in the magnitude of future earnings surprises and an increase in the absolute value of earnings announcement excess returns. We find no evidence that this reduction in disclosure is driven by a decrease in the firm?s forecasting ability; management forecast accuracy is indistinguishable post-litigation compared to a twelve-month window prior to the damage period. Our results hold after controlling for other potential determinants of disclosure choices such as CEO turnover, demand for disclosure, and economy-wide trends in disclosure.

Our evidence suggests that the litigation process encourages firms to decrease the provision of disclosures for which they may later be held accountable, despite the increased protections afforded by the Private Securities Litigation Reform Act of 1995. Our results seem inconsistent with the intentions of regulators and private litigants who seek enhanced corporate transparency.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on June 09, 2008 (boomark / email).