Corporate Disclosure Response to US SEC Revenue Recognition Litigation

• In Event: Accounting, Behavior, Organizations and Leadership

Abstract

This study investigates changes in the Form 10-K narrative disclosures of 29 firms in response to litigation instituted by the United States Securities and Exchange Commission (SEC). Prior research suggests that firms that engage in fraudulent financial reporting use disclosure complexity to avoid detection and litigation. Disclosure complexity or readability has been studied in relation to trading, earnings management, and the likelihood of the SEC filing an Accounting and Auditing Enforcement Release (AAER) initiating or reporting its investigation of alleged reporting irregularities. Our study focuses on changes in revenue recognition disclosures triggered by the onset of infringement and the release of a litigation settlement. Our sample is drawn from the 518 AAERs filed between 2009 and 2012. We screened the AAERs for firms suspected of fraudulent financial reporting relating to revenue recognition. Narrative disclosures related to revenue recognition contained within the Critical Accounting Policies and Significant Accounting Policies sections of the annual report were downloaded for the year preceding the dates of infringement listed on the AAER through the year following the issuance of the AAER. Because AAERs may be issued many years after alleged improper revenue recognition occurred, the per company period of disclosures ranges from 6 to 12 years. To determine if and where disclosure changes occur we analyze the disclosure word count, the Flesch Reading Ease scores, and the consistency of sentences from one year to the next. We find differences in the disclosure word counts during the infringement period, and change in the FRE scores in the post-infringement year. No changes were identified during the litigation period. We find firms added more sentences during the infringement period than the litigation period. Additional work on the narrative content may add additional insight into these findings.

Authors

• Benjamin B Vaughan, University of Vermont

• Susan Boedeker Hughes, University of Vermont

• Barbara Arel, University of Vermont