The Effect of Managerial Litigation Risk on Earnings Warnings: Evidence from a Natural Experiment

58 Pages Posted: 12 Nov 2020

See all articles by Ying Huang

Ying Huang

University of Texas at Dallas

Ningzhong Li

University of Texas at Dallas

Yong Yu

University of Texas at Austin

Xiaolu Zhou

University of Texas at Dallas

Multiple version iconThere are 2 versions of this paper

Date Written: September 23, 2020

Abstract

We examine the causal effect of managerial litigation risk on managers’ disclosure of earnings warnings in the face of large earnings shortfalls. Exploring the staggered adoption of universal demand (UD) laws as an exogenous decrease in litigation risk, we find that the adoption leads to a decrease in managers’ issuance of earnings warnings, especially among firms facing a higher litigation risk prior to the adoption. In contrast, we find no change in managers’ tendency to alert investors of impending large positive earnings surprises. Collectively, our results provide causal evidence that higher litigation risk incentivizes managers to issue more earnings warnings. Our results differ from Bourveau et al.’s (2018) finding of an increase in the frequency of management earnings forecasts after the adoption of UD laws. We reconcile our findings with theirs by demonstrating that the effect of adopting UD laws on management earnings forecasts depends critically on forecast horizon: The adoption increases long-horizon forecasts, but decreases short-horizon forecasts.

Keywords: Litigation Risk, Earnings Warning, Universal Demand Laws, Management Earnings Forecast, Forecast Horizon

JEL Classification: K41, M41

Suggested Citation

Huang, Ying and Li, Ningzhong and Yu, Yong and Zhou, Xiaolu, The Effect of Managerial Litigation Risk on Earnings Warnings: Evidence from a Natural Experiment (September 23, 2020). Available at SSRN: https://ssrn.com/abstract=3698391 or http://dx.doi.org/10.2139/ssrn.3698391

Ying Huang

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Ningzhong Li (Contact Author)

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Yong Yu

University of Texas at Austin ( email )

1 University Station B6400
Austin, TX 78712
United States
(512)471-6714 (Phone)
(512)471-3904 (Fax)

Xiaolu Zhou

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

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