Do Securities Class Actions Deter Misreporting?

Abstract

This paper investigates whether a U.S. circuit court ruling that made it easier for public corporations to defend against security class actions led to more misreporting. In a difference-in-differences framework, I find an increase in restatements for firms affected by the ruling relative to unaffected firms. Further, within affected firms, these results are concentrated among those that experienced the lowest abnormal returns to the ruling, the firms most likely to face meritorious litigation, and among those firms that saw the lowest increases in institutional ownership after the ruling. Inferences are similar examining cross-sectional tests in a levels framework. These results suggest that the threat of shareholder litigation can discipline managerial reporting practices and deter misreporting. As such, this evidence informs the debate about the role of securities class actions in regulating securities markets.

Keywords: misrepresentation, restatements, discretionary revenues, regulation, class action lawsuits

JEL Classification: K20, K22, K40, K41, K42, M41