Does Litigation Change Managers’ Beliefs About the Value of Voluntarily Disclosing Bad News?

Prior work calls into question litigation's effectiveness as a corporate governance mechanism, finding that litigation causes managers to reduce disclosure, perhaps stemming from a belief that even their good faith disclosures will be used against them. Digging deeper into this setting, we test whether the nature, timing and venue of disclosure, as well as managers' prior disclosure history and experience during the litigation process, matters. Consistent with Skinner (1994)'s classic legal liability hypothesis, we find that while managers reduce and delay their forecasts of positive earnings news following litigation, bad news forecasts actually increase and become timelier. Further, managers whose prior warnings were deemed insufficient and likely triggered legal and media scrutiny appear not to change their beliefs about the value of warning. Instead, they disclose bad news earlier and more often following litigation. Moreover, many managers who were non-guiders prior to facing legal scrutiny begin guiding following litigation. At the same time, we also find that lawsuit managers maintain (and in some cases, increase) their disclosure in other venues (i.e., press release disclosure and conference call discussions). Our evidence reconciles the finding that managers respond to litigation by reducing disclosure with the growing body of literature that finds that managers seek to and do use disclosure to lower their firms' litigation risk. At the same time, our evidence supports an important alternative viewpoint of how firms respond to litigation, as well as the effectiveness of litigation as a governance mechanism