PurposeThe purpose of this study is to examine whether firm-specific litigation risk affects independent director conservatism in the oversight of financial reporting.Design/methodology/approachThis study considers the enactment of Sarbanes–Oxley Act and the main US stock exchanges' corresponding corporate governance regulations in 2002–2003 as an exogenous shock event to increase board independence. OLS regressions with fixed effects are conducted to test the hypothesis.FindingsChanges in discretionary accruals from the pre-event year (2001) to the post-event year (2004) are more negatively associated with an exogenous increase in board independence for firms with high litigation risk than for firms with low litigation risk.Originality/valueThe results suggest that independent directors are more conservative in overseeing financial reporting when they face higher litigation risk, consistent with the notion that they are still concerned about liability risk although they seldom have to pay damages or legal fees out of their own pockets.
SYNOPSIS
This paper investigates the association between investor sentiment and accounting conservatism. We find that managers recognize economic losses in earnings in a more timely manner during periods of high investor sentiment. Further, the sentiment-conservatism relation is stronger for firms with greater sentiment-price sensitivity. We also find that the sentiment-conservatism association is stronger for firms with higher litigation risk and financial expert CEOs, and is weaker for firms with retiring CEOs. Overall, our results suggest that firms report earnings more conservatively in response to higher investor sentiment in order to mitigate potential litigation costs. These findings have implications for regulators and standard setters who have deemphasized accounting conservatism in recent years.
ABSTRACTPrior research finds that positive tone in firms' qualitative disclosures increases the risk of shareholder lawsuits. However, federal securities laws provide a safe harbor intended to shield firms' forward-looking statements from legal liability. One implication of this safe harbor is that litigation risk potentially varies between qualitative forward- and non-forward-looking statements. Consistent with this implication, we find that positive tone in forward-looking qualitative statements is significantly less related to the likelihood of subsequent litigation than is positive tone in non-forward-looking qualitative statements. On average, we fail to find a significant association between qualitative forward-looking statements and subsequent litigation. We do find evidence, however, that positive tone in qualitative forward-looking statements relates positively to subsequent litigation in two U.S. circuits in which court rulings reduced safe harbor protections for forward-looking statements. Overall, our results are consistent with the safe harbor effectively shielding firms' qualitative forward-looking statements from litigation risk.
