Does litigation deter or encourage real earnings management?

Sterling Huang, Sugata Roychowdhury, Ewa Sletten

Research output: Contribution to journalReview articlepeer-review

12 Scopus citations

Abstract

In this paper, we rely on an exogenous shock to examine the impact of litigation risk on real earnings management (REM). We conduct difference-in-differences tests centered on an unanticipated court ruling that reduced litigation risk for firms headquartered in the Ninth Circuit. REM increases significantly following the ruling for Ninth Circuit firms relative to other firms, consistent with litigation risk deterring REM. Additional analyses reveal that REM rises more following the ruling when firms issue more optimistic disclosures. The evidence is consistent with litigation deterring REM by constraining managers' ability to issue optimistic and misleading disclosures that can conceal the myopic and opportunistic motives underlying REM. We further document that an increase in REM in response to a decline in litigation risk is more pronounced when managers have higher incentives to manipulate earnings and governance mechanisms are weaker.

Original languageEnglish (US)
Pages (from-to)251-278
Number of pages28
JournalAccounting Review
Volume95
Issue number3
DOIs
StatePublished - May 2020
Externally publishedYes

Keywords

  • Corporate governance
  • Deterrence
  • Earnings management
  • Litigation
  • Real earnings management

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Fingerprint

Dive into the research topics of 'Does litigation deter or encourage real earnings management?'. Together they form a unique fingerprint.

Cite this