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Shareholder litigation risk and real earnings management: a causal inference

Review of accounting & finance, 2019-11, Vol.18 (4), p.557-588 [Peer Reviewed Journal]

Emerald Publishing Limited ;Emerald Publishing Limited 2019 ;ISSN: 1475-7702 ;EISSN: 1758-7700 ;DOI: 10.1108/RAF-06-2018-0122

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  • Title:
    Shareholder litigation risk and real earnings management: a causal inference
  • Author: Liao, Qunfeng ; Ouyang, Bo
  • Subjects: Asymmetry ; Corporate governance ; Costs ; Earnings ; Earnings management ; Economic models ; Evidence ; Federal court decisions ; Fiscal years ; Initial public offerings ; Litigation ; Losses ; Proxies ; R&D ; Research & development ; State court decisions ; Stockholders
  • Is Part Of: Review of accounting & finance, 2019-11, Vol.18 (4), p.557-588
  • Description: Purpose The authors study how shareholder litigation risk impacts a firm’s decision of real earnings management (REM). This paper aims to shed light on how shareholder litigation risk impacts REM. The authors further explore how the intensifying effect varies systematically conditioning on the degree of information asymmetry and the strength of internal corporate governance. Design/methodology/approach In this study, the authors use the 1999 Ninth Circuit Court ruling as a quasi-experiment that reduces shareholder litigation risk to address endogeneity and establish a causal inference. Findings The difference-in-difference tests suggest lower shareholder litigation risk intensifies REM. In other words, higher litigation risk mitigates REM. Cross-sectional test results suggest the negative effect of decreased shareholder litigation is more pronounced when monitoring difficulty is higher, when information environment is more impoverished and when internal corporate governance is weaker. The negative effect is also stronger in firms with higher sensitivity to legal threats. Originality/value Protection of investors’ interest is the focus of corporate governance. Designed as an important corporate governance mechanism, shareholder litigation enables investors to pursue legal actions to recover their losses in the event of corporate misbehaviors. However, whether shareholder litigation is an effective corporate governance tool and beneficial to shareholders and firms is not without controversy. The authors contribute to the debate by providing evidence that supports the argument that shareholder litigation threat significantly disciplines REM, a form of costlier earnings management technique and myopic investment behavior.
  • Publisher: Patrington: Emerald Publishing Limited
  • Language: English
  • Identifier: ISSN: 1475-7702
    EISSN: 1758-7700
    DOI: 10.1108/RAF-06-2018-0122
  • Source: ProQuest Central
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