Shareholder Litigation Risk and Readability of Corporate Financial Disclosures: Evidence from Natural Experiments

Abstract

We use a natural experiment to weigh conflicting theories on the impact of shareholder litigation risk on the readability of corporate financial disclosures. In response to a Ninth Circuit Court of Appeals ruling that unexpectedly reduced litigation risk, we find that firms in the Ninth Circuit significantly improved the readability of their financial disclosures relative to control firms. This supports the idea that litigation risk discourages firms from providing financial disclosures with greater readability. Our finding is robust to different linguistic complexity measures and matching techniques, fixed effects for both time-invariant and time-varying unobservable confounders, and an alternative natural experiment.

Keywords: Shareholder litigation risk, Corporate financial disclosure, Textual analysis, Endogeneity

JEL Classification: G32, G38, K22, K40