Does Court Stringency Affect Restatement Decisions?

Abstract

This study examines how heterogeneous pleading standards among courts affect firms’ propensity for making voluntary restatements. We find robust evidence that misreporting firms headquartered in court jurisdictions with higher dismissal rates (more lenient to firms) are more likely to make voluntary restatements. Using the U.S. Supreme Court’s Tellabs decision as an exogenous shock to the pleading standard in some district courts, we find similar evidence in a difference-in-differences analysis. Our findings, that firms are more likely to admit misreporting when the legal environment is lenient, cannot be inferred from previous research, which suggests that firms disclose bad news when facing high litigation risk. Thus, we provide new evidence on the complex relationship between the legal environment and financial reporting decisions.

Keywords: Private Securities Litigation, Pleading Standard, Accounting Misreporting, Restatement

JEL Classification: M41; K22; G39