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The Effect of Litigation Risk on Management Earnings Forecasts

Zhiyan Cao

University of Washington Tacoma

Ganapathi S. Narayanamoorthy

Tulane University - Accounting & Taxation

October 1, 2009

Yale SOM Working Paper No. 48

We examine the effect of litigation risk on management’s decision to issue earnings forecasts. We use a new ex ante measure of litigation risk, namely, the Directors and Officers liability insurance premium. This measure bypasses significant problems associated with the estimation of ex ante litigation risk in prior studies. By using this measure of litigation risk, our results are more intuitive. We find that, when faced with ex ante litigation risk, managers with bad news are more likely to issue an earnings warning. For good news firms, we do not see this effect. We also examine three forecast characteristics: forecast horizon, extent of news revealed, and forecast precision. Firms with higher litigation risk tend to issue earnings forecasts earlier if they have bad news, but this is not so when they have good news. They also reveal less news in the forecasts if they have good news. As litigation risk increases, bad news earnings forecasts tend to become more precise while good news earnings forecasts tend to become less precise. This differential effect of litigation risk on management earnings forecasts, based on the direction of the news, has not been documented by previous studies.

Number of Pages in PDF File: 58

Keywords: litigation risk, voluntary disclosure, management earnings forecasts, directors and officers insurance

JEL Classification: G39, K22, K41, M41, G29

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Date posted: November 23, 2005 ; Last revised: August 31, 2012

Suggested Citation

Cao, Zhiyan and Narayanamoorthy, Ganapathi S., The Effect of Litigation Risk on Management Earnings Forecasts (October 1, 2009). Yale SOM Working Paper No. 48. Available at SSRN: http://ssrn.com/abstract=853085

Contact Information

Zhiyan Cao
University of Washington Tacoma ( email )
1900 Commerce St, Campus Box 358420
Tacoma, WA 98402-3100
United States
(253) 692-4821 (Phone)
(253) 692-4523 (Fax)
Ganapathi S. Narayanamoorthy (Contact Author)
Tulane University - Accounting & Taxation ( email )
United States
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