Legal Expertise and the Role of Litigation Risk in Firms’ Conservatism Choices

54 Pages Posted: 2 Aug 2018 Last revised: 8 Aug 2021

See all articles by Jonathan Black

Jonathan Black

University of Melbourne - Department of Accounting

Charles (Chad) Ham

Indiana University - Kelley School of Business

Michael D. Kimbrough

University of Maryland - Robert H. Smith School of Business

Ha Yoon Yee

Purdue University - Krannert School of Management

Date Written: July 31, 2021

Abstract

Firms face a greater risk of lawsuits for overstated rather than understated earnings or net assets, suggesting conservatism can reduce firms’ expected legal costs. Because managers with legal expertise are more likely than other managers to recognize the legal benefits of conservatism, this study examines whether legal expertise among members of senior management promotes greater conservatism. Consistent with this prediction, we find that firms with a general counsel (GC) in senior management (our proxy for legal expertise) report more conservatively. We also find that GC firms recalibrate their conservatism levels in response to changes in the legal environment—their conservatism choices are more responsive to litigation against peer firms and to two judicial rulings that affected the litigation risk for firms located in the Ninth Circuit. Overall, our findings suggest that populating senior management with legal experts affects the extent to which a firm’s level of conservatism incorporates legal risks.

Keywords: Conservatism, Legal Expertise, Litigation Risk, General Counsel

JEL Classification: K40; M41

Suggested Citation

Black, Jonathan and Ham, Charles and Kimbrough, Michael D. and Yee, Ha Yoon, Legal Expertise and the Role of Litigation Risk in Firms’ Conservatism Choices (July 31, 2021). Available at SSRN: https://ssrn.com/abstract=3224887 or http://dx.doi.org/10.2139/ssrn.3224887

Jonathan Black (Contact Author)

University of Melbourne - Department of Accounting ( email )

Victoria
Melbourne, Victoria 3010 3010
Australia

Charles Ham

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

Michael D. Kimbrough

University of Maryland - Robert H. Smith School of Business ( email )

Robert H. Smith School of Business
College Park, MD 20742-9157
United States
301-405-8222 (Phone)
301-314-9414 (Fax)

Ha Yoon Yee

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

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