Do the Merits Matter More after Securities Litigation Reform? Evidence from Restatements, Earnings Forecasts, and Insider Trading

Abstract

This paper examines the effect of the Private Securities Litigation Reform Act of 1995 (PSLRA) on stockholder lawsuits. We explore the role of restatements, earnings forecasts, and insider trading in the filing and resolution of lawsuits for a sample of high technology firms. Consistent with expectations, there is a post-PSLRA shift away from litigation based on forward-looking earnings disclosures. Conversely, there is a significantly greater correlation between litigation and both earnings restatements and insider selling after the PSLRA. There is no evidence, however, of an association between litigation and abnormal insider selling either before or after the PSLRA, even though this measure conforms more closely with legal standards for assessing fraudulent intent. Finally, we find a post-PSLRA increase in the likelihood of settlement for cases involving earnings restatements and abnormal insider selling. Thus, unlike lawsuit filings, the outcome of litigation does conform with judicial doctrine regarding insider trading. Consistent with Skinner (1997), there is no association between the likelihood of settlement and firms' forward-looking earnings disclosures.

Keywords: stockholder litigation, restatements, earnings forecasts, insider trading

JEL Classification: M41, K22