Fair Value Accounting Standards and Securities Litigation

Abstract

We investigate the effect of fair value accounting standards on firms’ litigation risk. Commentators claim the discretion required by fair value standards allows plaintiffs to “second guess” managers’ judgments. However, fair value standards and their underlying transactions are complex, making it difficult for plaintiffs to allege the defendant intentionally misled investors. Consistent with this argument, we find firms that rely more on fair value standards are less likely to be sued. We also find firms with material restatements involving fair value violations are less likely to be sued for the restatement than are firms with material restatements involving non-fair-value GAAP violations. In targeted difference-in-differences tests, we find no evidence of a change in litigation risk after new fair value standards are passed (in the areas covered by the specific standards). Overall, our results suggest that fair value standards are a relatively low litigation risk area in GAAP.

Keywords: Fair Value Standards, Securities Litigation

JEL Classification: M41, G3, K4