Economic Effects of Litigation Risk on Corporate Disclosure and Innovation

Review of Accounting Studies (Forthcoming)

49 Pages Posted: 22 Aug 2022 Last revised: 16 Jun 2023

See all articles by Stefan Schantl

Stefan Schantl

The University of Melbourne - Department of Accounting

Alfred Wagenhofer

University of Graz

Date Written: March 3, 2023

Abstract

Empirical studies on the relationship between shareholder litigation and corporate disclosure obtain mixed results. We develop an economic model to capture the endogeneity between disclosure and litigation. Equilibrium disclosure is determined by two countervailing effects of litigation, a deterrence effect and an insurance effect. We derive four key results. (i) Decreasing litigation risk leads to less disclosure of very bad news, due to a weakening of the deterrence effect, but to more disclosure of weakly bad news, due to a weakening of the insurance effect. (ii) Given a sufficiently large information asymmetry, litigation risk negatively (positively) affects overall disclosure of bad news for low (high) litigation risk firms. (iii) Capital markets respond more to the disclosure of bad news than of good news if the deterrence effect is strong, which arises if both insiders' penalties and litigation risk are high. (iv) In an extension, we highlight real effects of litigation on corporate innovation and establish that innovation first decreases and then increases (strictly decreases) with litigation risk if insiders' penalties are small (large). We reconcile our findings with results from a large set of U.S.-based empirical studies and make several novel predictions.

Keywords: Private litigation, litigation risk, corporate disclosure, corporate innovation

JEL Classification: G18, K22, K41, K42, M41, M48

Suggested Citation

Schantl, Stefan and Wagenhofer, Alfred, Economic Effects of Litigation Risk on Corporate Disclosure and Innovation (March 3, 2023). Review of Accounting Studies (Forthcoming), Available at SSRN: https://ssrn.com/abstract=4193663 or http://dx.doi.org/10.2139/ssrn.4193663

Stefan Schantl (Contact Author)

The University of Melbourne - Department of Accounting ( email )

Victoria
Melbourne, Victoria 3010 3010
Australia

HOME PAGE: http://sites.google.com/view/stefan-f-schantl

Alfred Wagenhofer

University of Graz ( email )

Austria
+43 316 380 3500 (Phone)
+43 316 380 9565 (Fax)

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