Bogging Down Investors : An Unintended Consequence of Litigation Risk

This study examines the effect of litigation risk on the readability of corporate financial reports using the 1999 Silicon Graphics Inc. court ruling as a natural experiment. This ruling unexpectedly reduced the litigation risk of firms located in the states of the Ninth Circuit Court (treated firms). We find that the treated firms increase the readability of their financial reports after the ruling, relative to the control firms located in other states. The result is stronger for firms reporting bad news and firms reducing management earnings forecasts following the ruling. It is also more pronounced for firms with greater financial constraints, higher ex ante litigation risk, and higher risk of frivolous lawsuits. Further, investors find the 10-K reports of the treated firms more informative since the court ruling, especially for firms with low pre-ruling 10-K readability. Collectively, our findings support the notion that litigation risk contributes to low reporting readability