Are Firms Really Sued For Making Optimistic Disclosures? Litigation Risk and Forward vs Non-Forward-Looking Narrative Disclosures

• In Event: Even More Financial Reporting

Abstract

Recent research finds a positive link between disclosure tone and future securities lawsuits and concludes that optimistic qualitative statements subject firms to securities litigation risk. However, the Private Securities Litigation Reform Act provides a safe harbor intended to encourage forward-looking disclosures by shielding them from legal liability. We examine the link between forward-looking versus non-forward-looking statements and subsequent litigation and find that only the tone of non-forward-looking statements is associated with subsequent shareholder lawsuits. Our results suggest firms are not sued for optimistic statements regarding future events, consistent with the safe harbor provisions effectively mitigating litigation risk for forward-looking disclosures. We also find evidence suggesting the link between non-forward-looking disclosure tone and future litigation is driven primarily by a failure of firms to adequately disclose bad news rather than by firms’ excessive positive statements or “hype”. Future research should consider managers’ divergent reporting incentives for forward versus non-forward-looking statements when correlating measures of disclosure tone with other outcomes or determinants.

Authors

• John S. Treu, Pace University

• Kenneth Merkley, Cornell University

• Richard Arnold Cazier, University of Michigan-Ann Arbor