Post-litigation reporting conservatism

Abstract

We investigate changes in financial reporting conservatism arising from disclosure-related shareholder lawsuits filed between 1996 and 2016. We find that sued firms respond to 10b-5 litigation with increased accounting conservatism. Consistent with a spillover effect, we also find that non-sued peer firms increase accounting conservatism following litigation. Despite the FASB having eliminated conservatism as an essential qualitative characteristic from the conceptual framework in 2010, we find the post-suit spike in conservatism persists after 2010, suggesting a capital market demand for conservatism even without regulator intervention. Our results, which support the widespread but untested belief that litigation events induce accounting conservatism, extend prior studies examining the disclosure effects of litigation into the accounting choice effects of litigation.

Keywords: Litigation, Conservatism, Network externalities, Peer firm, FASB

JEL Classification: K22, G14, G18, G20, M41