Shareholder litigation risk and real earnings management: a causal inference

Qunfeng Liao, Bo Ouyang

Research output: Contribution to journalArticle

Abstract

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.

Original languageEnglish (US)
Pages (from-to)557-588
Number of pages32
JournalReview of Accounting and Finance
Volume18
Issue number4
DOIs
StatePublished - Nov 11 2019

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics, Econometrics and Finance(all)

Fingerprint Dive into the research topics of 'Shareholder litigation risk and real earnings management: a causal inference'. Together they form a unique fingerprint.

  • Cite this