Litigation Risk, Information Asymmetry and Conditional Conservatism

This study examines whether a change in litigiousness explains variations in the relationship between information asymmetry and conditional conservatism. Prior literature documents a positive association between information asymmetry and conservatism. Prior literature also demonstrates that shareholder litigation concerns motivate managers and auditors to be conservative in preparing financial statements. In a more litigious environment, both managers and auditors have incentives to be more sensitive to expected litigation costs which increase with the level of information asymmetry. We hypothesize and find that higher levels of litigiousness enhance the association between information asymmetry and conservatism. This topic is important given the role of conservatism in accounting practice and the recent tendency for standard setters to view conservatism in a negative light. Prior research argues that conservatism is a favorable characteristic in equity markets because of its information role. This study attempts to gain a further understanding of what affects that role