Conservative Reporting and Securities Class Action Lawsuits

Positive accounting theory predicts that conservative financial reporting averts GAAP-based litigation. However, very little empirical evidence addresses whether and how accounting conservatism provides these benefits. Using a sample of lawsuits against public companies for alleged violations of US GAAP, we examine the association of accounting conservatism with subsequent initiation of lawsuits and with four litigation outcomes: market reactions to lawsuits, duration of lawsuits, dismissals of lawsuits, and penalties approved by courts. We find that firms with greater degrees of conditional conservatism experience more favorable consequences on all five dimensions of litigation occurrence and outcomes. Two measures of unconditional conservatism are not associated with the litigation variables. Our study provides new empirical evidence supporting Watts’ (2003a) litigation explanation for accounting conservatism.

Keywords: accounting conservatism, litigation, lawsuit dismissal, lawsuit settlement

JEL Classification: M41

Suggested Citation: Suggested Citation

Ettredge, Michael L. and Huang, Ying and Zhang, Weining, Conservative Reporting and Securities Class Action Lawsuits (November 24, 2014). 2015 Canadian Academic Accounting Association (CAAA) Annual Conference, Accounting Horizons, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2129800 or http://dx.doi.org/10.2139/ssrn.2129800