Week 5 Houston

THE ACCOUNTING REVIEW American Accounting Association
Vol. 94, No. 5 DOI: 10.2308/accr-52355

September 2019
pp. 247–272
Litigation Risk and Voluntary Disclosure: Evidence from

Legal Changes
Joel F. Houston
University of Florida
Chen Lin
The University of Hong Kong
Sibo Liu
Lai Wei
Lingnan University
ABSTRACT: This paper documents that changes in litigation risk affect corporate voluntary disclosure practices. We
make causal inferences by exploiting three legal events that generate exogenous variations in firms’ litigation risk.
Using a matching-based fixed-effect difference-in-differences design, we find that the treated firms tend to make
fewer (more) management earnings forecasts relative to the control firms when they expect litigation risk to be lower
(higher) following the legal event. The results are concentrated on the earnings forecasts conveying negative news
and are robust to alternative specifications, samples, and outcome variables.
JEL Classifications: D80; G14; K22; K41; M41.
Keywords: earnings forecasts; litigation risk; shareholder protection.
I. INTRODUCTION
C
ompanies are often reluctant to voluntarily disclose information, despite the immense benefits that increased
transparency provide for capital market efficiency.1 Two possible explanations for this reluctance are the fear of
disclosing important proprietary information, and the fear that greater disclosure increases litigation risk. While the
literature has identified proprietary cost as an important constraint (e.g., Dedman and Lennox 2009), it remains unresolved
whether litigation risk increases or decreases corporate voluntary disclosure. In theory, expectation of litigation can either
encourage or discourage corporate voluntary disclosure (Healy and Palepu 2001). Under Rule 10b-5 promulgated by the U.S.
Securities and Exchange Commission (SEC), shareholders can sue companies for making untrue or misleading statements, or for
failing to disclose material information promptly.2 In anticipation of such litigation, firms may preemptively increase disclosure to
reduce the likelihood and/or cost of litigation that targets omission of material information (Skinner 1994, 1997; Kasznik and Lev
1995; Field, Lowry, and Shu 2005). On the other hand, disclosed information may trigger litigation if managers produce
We thank Mark L. DeFond and İrem Tuna (editors), two anonymous referees, Sumit Agarwal, Douglas Arner, David Donald, Joan Farre-Mensa,
Christopher James, Nitish Kumar, Kai Li, Micah Officer, Daniel Sokol, and Jennifer Wu Tucker for very helpful comments and discussions. Lin gratefully
acknowledges the financial support from The University of Hong Kong and the National Natural Science Foundation of China (No. 71790601).
Supplemental material can be accessed by clicking the link in Appendix C.
Editor’s note: Accepted by İrem Tuna, under the Senior Editorship of Mark L. DeFond.
Submitted: May 2016
Accepted: December 2018
Published Online: January 2019
1
Based on the classical works by Grossman (1981), Grossman and Hart (1980), and Milgrom (1981), full disclosure of information is the prevailing
equilibrium if there are no costs associated with disclosure, which then is beneficial to reduce information asymmetry and improve the efficiency of
stock prices in the capital market (Patell 1976; Ajinkya and Gift 1984; Waymire 1984; Lennox and Park 2006).
2
We provide two examples of class action lawsuits in Appendix A, in which firms were sued for either disseminating misleading statements or omitting
material information.
247
248 Houston, Lin, Liu, and Wei
statements that are later revealed to be overly optimistic (Skinner 1995; Johnson, Kasznik, and Nelson 2001) or if they make a
surprisingly negative statement that precipitates a large price drop (Francis, Philbrick, and Schipper 1994; Healy and Palepu
2001).3 In this scenario, expectation of litigation may make firms less willing to disclose material information.
While this issue has generated considerable attention, empirical evidence from prior research is largely mixed.4 A possible
cause for the mixed evidence is the endogenous relation between litigation risk and voluntary disclosure. In one respect, this
relation is subject to reverse causality. While litigation risk as a disciplining force can influence corporate policies such as
voluntary disclosure (La Porta, Lopez-de-Silanes, and Shleifer 2006), voluntary disclosure can also affect litigation risk by
varying the probabilities of class action lawsuits (Francis et al. 1994; Skinner 1994, 1997). A further concern is that litigation risk
is often measured imperfectly, as it is typically inferred from industry- and firm-specific characteristics that can be backward-
looking, time-varying, and capturing other firm aspects. Therefore, in order to identify the causal effect on voluntary disclosure
and to circumvent measurement problems, we need an event that changes litigation risk exogenously. At the same time, the
relation between litigation risk and voluntary disclosure can also be biased by omitted variables. For example, corporate disclosure
is likely to be affected by macro and specific trends. Ignoring these factors may generate a spurious relation between litigation risk
and voluntary disclosure.5 Therefore, we need an exogenous event that only affects the litigation risk of a subset of firms, so that
we can divide the firms into treated and control groups to implement the difference-in-differences design. In this way, we can
control the time trends and other concurrent changes to mitigate the omitted variable bias.
In this paper, we address these endogeneity problems by using three legal events, each of which generates a plausibly
exogenous change in the litigation risk for a subset of U.S. firms. Therefore, we can (1) construct a matched sample between the
treated and control firms, (2) implement the difference-in-differences design, and (3) incorporate an assortment of fixed effects,
such as firm fixed effects and year/industry-by-year fixed effects, to control for the time-invariant unobservable firm
characteristics and contemporaneous changes at either the macro or industry level. Using the matching-based fixed-effect
difference-in-differences approach, we can identify the causal effect of changes in litigation risk on changes in voluntary
disclosure, which will help resolve the mixed evidence in prior research concerning the relation between litigation risk and
corporate voluntary disclosure.
The first and primary legal event we use is the ruling from the Ninth Circuit Court of Appeals in 1999. This ruling
unexpectedly adopts a more stringent interpretation of the pleading standards enacted in the 1995 Private Securities Litigation
Reform Act (the Reform Act) compared to the other circuits (Cox, Thomas, and Bai 2009; Crane and Koch 2018).6 It requires
plaintiffs to plead facts before they can legally form a class, and to strongly infer that the defendants were ‘‘deliberately
reckless’’ in making the alleged misstatement or omitting any material statement. By contrast, in the other circuits, proving
mere recklessness is sufficient. In this regard, the ruling makes it much more difficult for plaintiffs to file securities class action
lawsuits against firms located in the states of the Ninth Circuit Court relative to firms in other states.7 Accordingly, firms
located in the Ninth Circuit states would expect a relative decrease in litigation. Indeed, we have demonstrated a greater
percentage reduction in the number of class action lawsuits in the Ninth Circuit Court relative to other jurisdictions. Since the
ruling applies to only a subset of firms in the U.S., we can assign the firms into treated and control groups according to their
locations, and implement the difference-in-differences design to estimate precisely the treatment effect of the Ninth Circuit
Court ruling. We further match firms by pre-ruling characteristics to ensure comparability between the treated and control
firms.8 In a more stringent specification, we also control for firm fixed effects, industry-by-year fixed effects, and state-specific
linear trends to further sharpen the identification.
We apply the matching-based fixed-effect difference-in-differences approach to 838 sample firms between 1995 and 2003,
a period that spans the four years before and after the ruling. In our main tests, we focus on the intensity of management
earnings forecasts, which reflects the first-order decision in a firm’s voluntary disclosure policies. We identify a significant
decline in the tendency and frequency of management earnings forecasts for firms affected by the ruling relative to an
3
Prior literature delivers a stylized fact of securities class action lawsuits—that a large one-time stock price drop tends to precipitate the filing of lawsuits
because it can be argued as evidence of omission of adverse news given an informationally efficient stock market (the ‘‘fraud on the market’’ theory)
(e.g., Skinner 1994, 1997; Francis et al. 1994; Grundfest and Perino 1997; Field et al. 2005).
4
Findings in Skinner (1994, 1997) and Kasznik and Lev (1995) imply a positive relation between litigation risk and voluntary disclosure, whereas
Francis et al. (1994), Johnson et al. (2001), and Baginski, Hassell, and Kimbrough (2002) find support for the opposite. Field et al. (2005) have
considered the simultaneity of the relation in their empirical model.
5
The bias can be either positive or negative, depending on the direction of association between the omitted variables and litigation risk.
6
The Reform Act was enacted to address the harassment that firms had with frivolous lawsuits targeting on large stock price declines regardless of the
actual culpability in disclosure practices (Johnson et al. 2001; Chu 2017). It raises the pleading standards in the litigation process and heightens the
difficulty of bringing securities class actions at the federal level (Levine and Pritchard 1998).
7
The nine states in the Ninth Circuit are Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington.
8
In our main analysis, we match the treated and control firms using propensity scores, but our results are robust to the alternative sample matched on the
nearest Mahalanobis distance.
The Accounting Review

Volume 94, Number 5, 2019
Litigation Risk and Voluntary Disclosure: Evidence from Legal Changes 249
unaffected control group. This positive relation between the expectation of litigation and voluntary disclosure suggests that
earnings forecast strategies are often designed to deter litigation. We also explore the effect of the ruling on the properties of
voluntary disclosure. When we take the tendency of disclosure into the construction of the property measures, we document a
decrease in forecast properties following the Ninth Circuit ruling. However, when we restrict the analysis to a sample of
observations with earnings forecasts, we find little evidence that firms change the manner in which they provide earnings
forecasts. This suggests that the major driving force of the findings comes from the extensive margin.
Furthermore, we disentangle the ruling’s effect on the disclosure of positive and negative news. Consistent with Skinner
(1994), who suggests that managers often face an asymmetric loss function when choosing disclosure policies, we document
that the treated firms are significantly less likely to issue negative news forecasts after the ruling, whereas there is no impact on
the incidence of positive news forecasts. These results indicate that prior to the ruling, managers were more fearful of the
litigation risk associated with the withholding of negative information.
We then conduct a battery of robustness tests to address concerns that our results may be confounded by contemporaneous
events. First, a considerable number of firms located in the Ninth Circuit region, particularly those in California, are high-tech
companies that were likely affected by the internet boom and bust around 2000. Therefore, we (1) include state-level economic
factors as additional controls for regional macro conditions; (2) exclude high-tech firms to mitigate the concern that the results
are driven by specific economic conditions in the Ninth Circuit states or by the timing of the internet bubble burst; (3) restrict
the sample to only include consistent forecasters—this restriction mitigates the effects related to compositional changes in the
Ninth Circuit resulting from mergers or firms that went out of business during the post-ruling period; and (4) focus on a shorter
event window using a quarterly forecast sample, where the findings are less susceptible to the confounding factors. The results
are robust to these additional controls and alternative samples.
Second, the litigation environment in the controlling states or periods may not always stay constant. Therefore, we (1)
exclude the firms that went public during our sample period to mitigate the influences from the surge of initial public offering
(IPO) allocation lawsuits around 2001; (2) use firms in the Second Circuit for the control group, where the interpretation of the
pleading standards is relatively stable (Cazier, Christensen, Merkley, and Treu 2016); and (3) exclude the firms with class
action lawsuits prior to the ruling, since, arguably, these earlier experiences can shape a firm’s subsequent incentives to
voluntarily disclose information (Rogers and Van Buskirk 2009). Third, we address the coverage issue of management earnings
forecasts using alternative measures of voluntary disclosure. We focus on the voluntary 8-K filings of firms and observe among
the treated firms a reduction in the frequency and informativeness of the filings relative to the control firms after the Ninth
Circuit Court ruling.
Finally, we perform similar analysis based on two additional legal events. First, we utilize the 2007 Supreme Court
decision that instituted a more uniform standard on securities class actions across circuit courts. This ruling reversed the
relatively tough pleading standards for securities class actions in the Ninth Circuit Court, thereby generating a relative increase
in the litigation risk of firms located in that region. Consistent with this reversal, we observe an opposite change in the quantity
of earnings forecasts compared to the effects surrounding the original ruling. Specifically, the firms in the Ninth Circuit Court
become more likely to make earnings forecasts, which is again consistent with the notion that corporate disclosure strategies are
often designed to deter litigation. Second, we explore the effect of the 2001 change in Nevada corporate law that also
effectively lowered litigation risk. Consistent with the findings using the Ninth Circuit Court ruling, we find that the Nevada
firms were less likely to make earnings forecasts when the litigation environment becomes more favorable.
This paper makes several contributions to the literature. First, it adds to the longstanding debate regarding the relation
between litigation risk and corporate voluntary disclosure. While previous studies have examined this relation using different
settings and litigation measures, the empirical evidence remains mixed. Johnson et al. (2001) study the effect of the 1995
Reform Act and document an increase in forward-looking disclosure by high-tech companies. Cazier et al. (2016) use the Ninth
Circuit Court ruling and find an increase in non-GAAP (generally accepted accounting principles) reporting. Both papers imply
that litigation risk limits voluntary disclosure. On the other hand, Naughton, Rusticus, Wang, and Yeung (2019) and Sikochi
(2016) find diminished transparency in the aftermath of a ruling that reduced the litigation risk for foreign firms listed in the
U.S. Cazier and Merkley (2016) find a positive relation between litigation risk and the volume, pessimistic tones, and
transparency of 10-K reports using a firm-specific litigation risk measure. Their findings suggest that litigation risk promotes
voluntary disclosure.
Our work differs from these studies in both the research scope and empirical strategies. First, we exploit three exogenous
legal events to identify a causal relation with the following advantages: (1) we implement matching between clearly defined
treated and control firms to ensure that they share similar characteristics, as the events only affect a subset of firms in the U.S.;9
9
The 1995 Reform Act is a nationwide reform that applies to all the firms in the U.S. Therefore, it is not easy to distinguish the impact of the reform from
a general time trend of increasing disclosure, given the pre-post comparison strategy adopted by Johnson et al. (2001).

(2) we apply the difference-in-differences method to the matched sample, where the general increasing trend in disclosure can
be captured by the control firms; (3) we control for firm fixed effects, industry-by-year fixed effects, and state linear trends to
condition out the effect of time-invariant unobservable factors within a firm and time-varying confounding factors in an
industry or a state; (4) we validate the settings as exogenous shocks to the litigation environment; and (5) we use the 2007
ruling as a reverse experiment to confirm the causal effect of litigation risk on voluntary disclosure. Furthermore, we focus on
litigation risk arising from both class actions and general lawsuits (e.g., 2001 Nevada corporate law amendment) and our
research utilizes all listed firms in the U.S. rather than a particular group (e.g., high-tech companies or cross-listed firms).
Our paper also contributes to the broader literature on shareholder litigation as a potential governance mechanism.
Shareholder litigation shapes corporate policies and affects shareholder wealth in various ways (Romano 1991; Gande and
Lewis 2009). Lin, Officer, Wang, and Zou (2013) find that firms with greater litigation protection face higher financing costs.
Hanley and Hoberg (2012), Hughes and Thakor (1992), and Lowry and Shu (2002) show the influence of litigation risk on the
pricing decisions in IPO. Lin, Officer, and Zou (2011) document the effect of litigation risk on mergers and acquisitions. Our
paper emphasizes the effect of litigation risk on corporate disclosure policy, the formation of which also has relevant
implications for investor protection.
The remainder of the paper is organized as follows. Section II reviews the related literature and introduces the legal
background of the securities litigation regulations concerning information disclosures. Section III describes our data sources
and outlines our identification strategy. Sections IV and V discuss empirical findings and provide concluding remarks,
respectively.
II. RELATED LITERATURE AND LEGAL BACKGROUND

In this section, we review the related literature on corporate earnings forecasts with a particular focus on its relation to the
litigation environment. We also provide details on the recent history of securities litigation reform and the specific rulings that
generate an exogenous variation in the litigation threat for firms in the Ninth Circuit.
Related Literature on Litigation Risk and Earnings Forecasts

Much of the seminal work on information economics assumes costless and credible communication, which creates an
environment where informed parties are always interested in full disclosure as a means of overcoming adverse selection
problems (Grossman 1981; Grossman and Hart 1980; Milgrom 1981). But in reality, corporate disclosure is often infrequent
and insufficient, despite information asymmetries between managers and outside investors. This considerable discrepancy
between theory and practice has spurred a large group of researchers to explore the various forces that influence management
earnings forecasts, which are one of the major forms of corporate disclosure. Chief among these forces is litigation risk, the
effects of which have generated considerable debate within both the theoretical and empirical literature.
Theoretically, litigation threats can have two opposing effects on corporate disclosure practices because of the tension that
has been built into the statutes governing disclosure-related securities fraud. According to Section 10b of the Securities
Exchange Act of 1934 and SEC Rule 10b-5 promulgated under the section, it is unlawful ‘‘to make any untrue statement of a
material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances
under which they were made, not misleading.’’ On the one hand, potential lawsuits that target misstatement can limit
information disclosures for which firms may later be held accountable. This mitigating effect can be stronger for the disclosure
of forward-looking information because forecast errors that attract litigation could be simply due to unexpected shocks instead
of deliberate fraudulent intent (Healy and Palepu 2001). On the other hand, lawsuits that focus on insufficient disclosure can
encourage firms to make more informative earnings forecasts ex ante. By keeping investors updated over time, information can
be smoothed out in the market, which limits large surprises that tend to trigger litigation.10 Therefore, it is not clear on a net
basis whether an increase in the litigation risk would enhance voluntary disclosure.
Skinner (1994) is among the first to provide empirical support for a positive relation between litigation risk and disclosure
of earnings forecasts. He argues that preemptive disclosures made by firms (in anticipation of litigation) can undercut potential
plaintiffs’ allegations that managers have failed to state material information, shorten class period (i.e., the period of non-
disclosure), and reduce class size (i.e., the potential pool of plaintiffs, consisting of investors engaging in stock purchases and
sales), all of which will lead to a lowering of expected legal costs (Skinner 1997). Kasznik and Lev (1995) similarly find that
10
Based on the ‘‘fraud on the market’’ theory, all value-relevant information shall be reflected in the stock prices efficiently; hence, plaintiffs can rely on
the market price to ‘‘detect’’ and allege a fraud, rather than demonstrate direct reliance on certain misrepresentation or omission of information that
affects their securities trading decisions (Francis et al. 1994). The theory had been adopted by many courts since the mid-1970s and was affirmed by the
Supreme Court in 1988 (Skinner 1995).

firms tend to preempt negative earnings surprises with discretionary disclosure, consistent with the litigation-deterring motives
of earnings forecasts, as suggested by Skinner (1994). The argument is also supported by Field et al. (2005), who show that
disclosure can deter certain types of litigation. These studies imply that higher litigation risk is associated with greater voluntary
disclosure.
However, Francis et al. (1994) observe little evidence that pre-disclosures deter litigation. Instead, they find that a
considerable portion of these pre-disclosures are themselves targeted by lawsuits, which suggests that the firms will provide less
voluntary disclosure when expecting greater litigation. In addition, Baginski, Hassell, and Kimbrough (2002) observe greater
disclosure by Canadian firms compared to the U.S. firms, and they attribute the difference to a less litigious environment in
Canada. Johnson et al. (2001) document an increase of forward-looking disclosures after the passage of the Reform Act in 1995
that reduces litigation risk for the U.S. firms. These two studies imply that litigation risk suppresses voluntary disclosure.
Given both the theoretical and empirical contradictions, we do not draw a directional prediction regarding the impact of
perceived litigation risk on earnings forecasts, but instead we leave it as an ultimately empirical question. We will also
investigate empirically the effects of perceived litigation risk on the forecasts of positive versus negative news, because
different news contents are weighted differently by the managers in their assessment of litigation risk.
Legal Background of the Securities Litigation Reform Act and the Ninth Circuit Court Ruling
The Private Securities Litigation Reform Act, enacted in 1995, is a milestone in the reform of federal securities laws that
govern securities fraud class actions. While, in principle, shareholder litigation serves as a potentially valuable governance
mechanism when managers breach their fiduciary duties (Cheng, Huang, Li, and Lobo 2010; Ferris, Jandik, Lawless, and
Makhija 2007; McTier and Wald 2011), individual shareholders may not appropriately utilize this tool in a way that protects the
interests of all the shareholders. Prior to the Reform Act, plaintiffs were able to bring lawsuits against firms with minimal
evidence of fraud, such as large fluctuation of stock prices, based on the ‘‘fraud on the market’’ theory. As a result, a non-
negligible portion of lawsuits with dubious merit were filed on a regular basis, often targeting defendants with ‘‘deep-pockets’’
(Johnson et al. 2001). These abuses imposed excessive burdens on firms and led to the birth of the Reform Act.
The Reform Act has introduced an assortment of procedural hurdles to curb potentially frivolous lawsuits. First, it
heightens the pleading standards to initiate securities class action lawsuits. To legally form a class, plaintiffs must identify
particularity facts giving rise to a ‘‘strong inference’’ that the defendants acted or omitted to act with scienter (i.e., with ‘‘the
required state of mind’’ for fraud). The proof of scienter becomes especially difficult in conjunction with the ‘‘stay of discovery’’
provision under the Reform Act, which prevents plaintiffs from a discovery process (e.g., to access witnesses or documents
from the defendant) if the defendant has filed a motion to dismiss the case. Furthermore, it provides additional protection over
forward-looking statements via the ‘‘safe harbor provision.’’ As long as the forecast is made in good faith and with meaningful
cautionary language, it is not subject to liability (Levine and Pritchard 1998; Johnson et al. 2001).11
While the Reform Act has contributed to a less litigious environment for all firms, the pleading standards, as a practical
matter, receive various independent interpretations from U.S. circuit courts (Chu 2017; Crane and Koch 2018), of which the
interpretation by the Ninth Circuit Court in the Silicon Graphics case is the most stringent. According to the ruling on July 2,
1999, plaintiffs must plead facts to strongly infer that the defendants were ‘‘deliberately reckless’’ in making the alleged
misstatement or omitting any material statement, whereas in the other circuits, proving mere recklessness is sufficient.12 This
remarkable decision applies to all the securities class actions subsequently filed with the Ninth Circuit Court. Indeed, as
demonstrated below, the number of class action lawsuits decreased 50 percent more in the Ninth Circuit Court compared to the
other courts of appeals, suggesting that firms located in the nine states of the Ninth Circuit Court would expect a much lower
probability of litigation following the ruling.13 Moreover, the court decision was largely unanticipated, as suggested by
anecdotal evidence and our analysis below. It is hence unlikely that the firms preemptively altered their disclosure behaviors in
anticipation of the ruling outcome. Therefore, the 1999 Ninth Circuit Court ruling provides a valid test ground to evaluate the
effect of greater litigation risk on management earnings forecasts.
11
Other provisions include appointing the class member with the largest economic stake as the lead plaintiff, limiting attorneys’ fees, and allowing the
defendant to recover defense expenses from the plaintiffs and/or their attorneys under certain circumstances.
12
In Re: Silicon Graphics Inc. Securities Litigation, 183 F. 3d 970 (9th Cir. 1999), shareholders allege that managers of Silicon Graphics issued
misleading statements to inflate the value of a company’s stock and they benefited from the misstatement through insider trading. The Ninth Circuit
Court dismissed the complaints because the court concluded that ‘‘general allegations regarding negative internal reports and stock sales do not give rise
to a strong inference of fraudulent intent.’’
13
This fact is further strengthened by the evidence that the plaintiffs rarely switch the filing venue to circumvent the heighted pleading standards (Cox et
al. 2009). For one thing, out-of-home circuit filings are usually consolidated into the home circuit of the defendant by federal legal procedures or by the
defendants’ motion to relocate the lawsuit; for another, the plaintiffs themselves are usually reluctant to file in another circuit for fear of significant costs
and delays in the litigation process.

In June 2007, the Supreme Court reversed a prior ruling in the Seventh Circuit on the case of Tellabs, Inc. v. Makor Issues
& Rights, Ltd, representing its first effort to interpret the ‘‘strong inference’’ pleading standards set in the Reform Act. By
rejecting a lenient pleading standard in the Seventh Circuit Court, the decision reversed the stringent standards followed by the
Ninth Circuit Court, which also transformed the divergent interpretations across circuits to a relatively uniform standard.14
Since litigation risk increases for the firms in the Ninth Circuit Court following this reversal, we can examine whether they
exhibit opposite changes in their earnings forecast behaviors compared to their practices around the 1999 Ninth Circuit Court
ruling.
III. SAMPLE, DATA, AND EMPIRICAL STRATEGY

In this section, we discuss in detail the identification strategy derived from the 1999 Ninth Circuit Court ruling. We then
describe the sample construction and measurements of key variables. The detailed definitions of all the variables in our analysis
are provided in Appendix B.
Setting and Research Design

We examine the effect of litigation risk on corporate earnings forecast decisions using a regression model with fixed effects
on a matched sample. To establish causality, we employ the Ninth Circuit ruling in 1999 as a quasi-natural experiment, which
decreases the litigation risk of firms within the district of the Ninth Circuit Court.
Our treated firms are those located in the Ninth Circuit that were subject to the ruling in 1999. We restrict the sample period
to 1995 to 2003, covering the four years before and after the ruling year. Years prior to 1995 are not included because the
Reform Act in 1995 significantly switched the litigation environment governing securities class actions. We perform propensity
score matching over a large spectrum of covariates to construct a matched sample. First, we estimate the propensity of a firm
being treated based on its average firm size, average leverage, average market-to-book (MTB) ratio, average return on assets
(ROA), average return volatility, average analyst coverage, average institutional ownership, and average forecast intensity
(proxied by the number of earnings forecasts) over the four years in the pre-ruling period. Then, we match the treated and
control firms one-to-one based on the nearest propensity score and allowing for replacement. As we demonstrate below, the
matched sample ensures that the pre-ruling firm characteristics and disclosure trends are parallel and comparable between the
treated and control firms.15 This approach allows us to implement the following difference-in-differences model:
Discit ¼ a þ bNinthi 3 Post1999t þ cXit þ hi þ dt þ eit ð1Þ
Discit captures several core dimensions of management earnings forecasts. We focus on the forecast intensity (Disclosure
and Frequency) and also explore the other properties, such as forecast horizon (Horizon), form specificity (Precision), and
accuracy (Accuracy). Ninthi differentiates the treatment and control group by taking the value of 1 when the firm is located in
the Ninth Circuit states, and 0 for the matched control firms. Post1999t is the time dummy set to 1 when the fiscal year is after
1999, and 0 otherwise. Xit contains the set of control variables, including basic financial variables of firms and other
determinants of earnings forecast practices. Firm fixed effects, hi, are included to control for time-invariant firm characteristics.
ht, under different specifications, denotes either year fixed effects or industry-by-year fixed effects. These time fixed effects
further capture the contemporaneous changes at the macro or industry level to mitigate the concerns about potential
confounding events. The standalone terms of Ninthi and Post1999t are absorbed by the firm and time fixed effects, respectively;
thus, they do not appear in Equation (1). In a more stringent specification, we further include a linear time trend for each state in
the control vector so that the trends in other shaping forces of earnings forecasts at the regional level will not confound the
results. The model is estimated using the Ordinary Least Squares (OLS) method with fixed effects. We are particularly
interested in b, the coefficient associated with the interaction term Ninth 3 Post1999, because it gives us the difference-in-
differences estimate of the effect from the Ninth Circuit ruling.
14
According to Choi and Pritchard (2012), the interpretation of the ‘‘strong inference’’ standards across circuit courts can be categorized into three groups.
The Second, Eighth, Tenth, and Eleventh Circuits are the benchmark group with a medium level of stringency. The relatively stringent are the First,
Fourth, Sixth, and Ninth Circuits, where the Ninth Circuit is the most stringent; the other circuits have relatively lenient interpretation, and the Third
and Seventh Circuits are the most generous. They document that after the Supreme Court’s decision of Tellabs, the dismissal rate of 10b-5 class action
lawsuits decreases among the previously stringent group, with the reduction in the Ninth Circuit Court the most prominent. This indicates that it
becomes easier for plaintiffs to form class (i.e., less likely to be dismissed) and sue the firms in the Ninth Circuit Court, hence imposing greater
litigation threat for the firms located in the region.
15
We also follow Abadie and Imbens (2006) and employ the nearest-neighbor matching approach to construct an alternative matched sample based on
the Mahalanobis distance between matching covariates (i.e., the Fama-French 48 industry, and the average value of firm size, leverage, and MTB ratio
over the four years before the ruling). The results are robust to the alternative matched sample.

Data and Variables

As stated above, the treated firms are those located in the states within the Ninth Circuit. To accurately identify the treated
firms, we need information on firms’ historical locations. We start with all the Compustat firms between 1995 and 2003. As
Compustat does not provide historical information about a firm’s location, we merge the firms to their 10-K filings by CIK
codes to obtain their historical business addresses, and we use these addresses to determine in which states the firms were
located. The data on business addresses from 10-K filings are extracted from the SEC’s EDGAR website and compiled by Bill
McDonald.16 We then merge the firms with those covered by the First Call Historical Database (FCHD) of Thomson Reuters,
which is the data source for management earnings forecasts. To make sure that each firm has presence both prior to and after the
ruling, we require firm-level data (all the variables used for propensity score matching) to be available in both the pre- and post-
ruling period. A total of 467 treated firms result from these procedures, and we obtain the one-to-one matched control firms
using propensity scores, as described in Section III. This procedure gives us a total of 6,710 firm-year observations for 838
unique firms in the final sample. To construct the measures of management earnings forecasts, we obtain the data from the
Company Issued Guidance (CIG) section in FCHD. All the measurements based on both annual and quarterly forecasts of
earnings per share (EPS) are aggregated at the firm-year level. The pre-announcement of earnings is not considered in the
construction process. We focus on a variety of dimensions of earnings forecasts. Disclosure is a binary variable set to 1 when a
firm issues an earnings forecast at least once in a fiscal year, and 0 otherwise. Frequency is the total number of earnings
forecasts made by a firm in a fiscal year. Both Disclosure and Frequency quantify the intensity of managers’ forecasting
practices. We construct two versions of measures of the forecast properties. The first version is constructed to reflect disclosure
decisions at both the extensive and intensive margin and it helps avoid sample truncation. Horizon is defined as the average
number of days between a forecast and the corresponding relevant fiscal year-end date. Following Li (2010), this measure is set
to 0 if a firm discloses no earnings forecasts in a fiscal year. In this measure, two layers of information are incorporated: (1)
whether the firm issues an earnings forecast in the first place; and (2) how timely the forecast is upon the issuance. In our
subsequent analysis, we use Ln_Horizon, which is defined as the natural logarithm of 1 plus Horizon.
To proxy for the specificity of forecasts, we assign each forecast a score ranging from 1 to 4. We designate a value of 1 for
qualitative forecasts, 2 for open-ended forecasts, 3 for range estimates, and 4 for point estimates. Using this classification,
Precision is defined as the average score of earnings forecasts made by a firm during a fiscal year, and 0 when no forecast is
issued. Accuracy is defined as an average score based on forecast errors. Specifically, we sort the forecast errors into quintiles,
where the errors are gauged by the absolute difference between the forecast value and the actual earnings scaled by the stock
price at the end of the month prior to the forecast. A forecast is assigned the value of 1 if it has error in the top quintile, 2 if the
error is in the second quintile, 3 if the error is in the third quintile, 4 if the error is in the fourth quintile, 5 if the forecast is in the
bottom quintile, and 0 if no forecast is issued. That is, a higher score indicates that a firm is more likely to issue an earnings
forecast and that the forecast is more accurate. For each of the three measures on forecast properties, we construct another
version based on the observations with at least one earnings forecast. This version provides information on the decision choices
of forecast manners at the intensive margin (i.e., conditional on a forecast being made), in addition to the untruncated property
measures where the first-order forecast issuance decision is incorporated.
To facilitate the test on the differential effect of the ruling on the management earnings forecasts conveying positive and
negative news, we further distinguish the management forecasts by their news content. We classify a management forecast as
containing positive (negative) news if its estimate is above (below) the prevailing analyst consensus, which is measured by the
average earnings forecasts provided by the analysts in the 90 days prior to it. In some cases, especially after the passage of
Regulation Fair Disclosure (Reg FD) in 2000, management forecasts are issued in conjunction with earnings announcements (i.e.,
bundled forecasts), so that the latest earnings information may not be fully incorporated in the prevailing analyst consensus.
Therefore, in these cases, we follow Rogers and Van Buskirk (2013) and project an updated analyst consensus that is based on the
earnings announcement.17 First, we use the parameters in their models to estimate an update that the analysts should make to their
forecasts given the new information in the earnings announcement. Then, we add the estimated update to each analyst forecast to
obtain a conditional version. Next, we calculate the updated analyst consensus by taking the average of the conditional analyst
forecasts in the 90 days prior to the issuance of a bundled forecast and use it as the new benchmark for news classification.18
16
The compiled data are available at: https://sraf.nd.edu/data/augmented-10-x-header-data/. When a firm’s historical business address is not available, we
use its headquarter state in Compustat to determine its location.
17
Bundled forecasts are defined as those issued in the five-day window around an earnings announcement, following Rogers and Van Buskirk (2013).
18
For quantitative forecasts, news content is positive (negative) if the point estimate—the midpoint of a range estimate, or the lower (upper) boundary of
an open-ended estimate—is above (below) the average analyst forecasts prevailing in the 90 days prior to the management forecast adjusted for any
bundling effect. For qualitative forecasts, we use the CIG news code following the rules outlined in Anilowski et al. (2007). We also use the upper
bound of range forecasts to redefine news content, as Ciconte, Kirk, and Tucker (2014) suggest that managers’ true expectations are close to the upper
bound of range forecasts. Our results are robust to the alternative definition.

Finally, we construct Disclosure and Frequency separately for the management forecasts conveying positive and negative news in
each firm-year.
We include in the main regression analyses an assortment of financial variables, such as the natural logarithm of total assets
(Log (Assets)), leverage (Leverage), market-to-book ratio (MTB), and profitability (ROA), to control for the time-varying effects
of a firm’s fundamentals on its forecast practices. In addition, we include other standard control variables in the literature, such
as stock return volatility (Return Volatility), the number of analysts following the firm (Analyst Coverage), and institutional
holdings (Institutional Ownership).19 The detailed definitions of the dependent and control variables can be found in Appendix
B.
Summary statistics of the variables in the baseline regressions are presented in Panel A of Table 1. All continuous variables
are winsorized at the 1st and 99th percentiles to mitigate the effect of outliers. As for earnings forecast practices, firms in our
sample, on average, have a 40 percent probability of issuing at least one forecast in a fiscal year. They issue approximately 1.30
forecasts per year. In terms of other firm-level characteristics, the sample firms, on average, have $336 million in total assets, a
leverage ratio of 0.14, an MTB ratio of 3.45, and a return on assets ratio of 9 percent. The average annual volatility of daily
stock returns is about 0.04. About eight analysts are following an average firm, and institutional investors hold around 38.8
percent of its outstanding shares.
IV. EMPIRICAL RESULTS

In this section, we deliver and discuss the empirical findings in detail. We first present evidence that renders support for the
validity of our setting. We then show the baseline results concerning the effect of the Ninth Circuit ruling and the basic
dimensions of earnings forecasts. We next disentangle the effect of the ruling on the disclosure of positive news and negative
news. Finally, we conduct a battery of robustness tests to further strengthen the empirical evidence.
Setting Validity
As reviewed in Section II, the empirically documented effect of litigation risk on management earnings forecasts is mixed,
arguably due to the endogenous nature of the two constructs. Therefore, to establish a causal relation between litigation risk and
forecast practices of the firms, we need to first verify the validity of the 1999 Ninth Circuit Court ruling outcome as a plausibly
exogenous shock to the litigation environment surrounding firms located in the Ninth Circuit states. Apart from referring to the
anecdotal evidence and related studies that address the issue (e.g., Johnson, Nelson, and Pritchard 1999; Crane and Koch 2018),
we perform several direct tests on the validity of the setting.
First, we compare the various aspects of management earnings forecasts and fundamental characteristics between the
treated firms and control firms in the pre-ruling period. By imposing the propensity score matching criteria on the average value
of firm size, leverage, MTB ratio, ROA, return volatility, analyst coverage, institutional ownership, and earnings forecast
frequency over 1995–1998, we ensure that the treated and control groups exhibit no systematic differences prior to the ruling.
We present the balance tests of the forecast variables and matching covariates in Panel B of Table 1. According to the test
statistics, the mean values of the matching covariates are insignificantly different between the treated and control firms. There is
also no significant difference in the various dimensions of pre-ruling earnings forecasts (i.e., Disclosure, Frequency, Ln_
Horizon, Precision, and Accuracy) made by the treated firms versus the control firms. The test results also suggest that reverse
causality is less of a concern in our study because there is no evidence that the ruling was a response to any differential
voluntary disclosure practices of the firms located in the Ninth Circuit states, or that firms preemptively alter their disclosure
behaviors in anticipation of the ruling outcome.
Second, we conduct a formal test on the relation between preexisting forecast behaviors of firms and the ruling of the Ninth
Circuit Court at the state level. We aggregate each earnings forecast measure by calculating the average value across all the
firms in each state-year prior to the ruling, and then regress the indicator variable, Ninth, on each of the five aggregated
measures of earnings forecasts. As defined above, Ninth is set equal to 1 for the states in the Ninth Circuit Court, and 0
otherwise. We use a Logit model to estimate the predictive power of preexisting earnings forecasts on the instance of the ruling,
and we include state-level GDP growth rate, the natural logarithm of GDP per capita, and the natural logarithm of the number
of public firms as control variables in the regression. The regression results are presented in Table 2. As shown by the
coefficient of the aggregated measures of earnings forecasts prior to the ruling, none of the estimates are statistically significant.
The results confirm the fact that the Ninth Circuit Court ruling outcome is not a result of the preexisting disclosure practices of
firms in the Ninth Circuit states, nor do the firms anticipate the ruling outcome and change their forecast behaviors ex ante.
19
As a robustness check, we also construct an indicator variable Loss to tag the years when a firm makes a loss, and Analyst Dispersion to control for the
degree of information asymmetry. All the results hold when we include the full set of control variables.

TABLE 1
Summary Statistics and Balance Tests
Panel A: Descriptive Statistics

Variable n Mean SD P25 Median P75
Ninth 6,710 0.558 0.497 0 1 1
Disclosure 6,710 0.402 0.49 0 0 1
Frequency 6,710 1.304 2.507 0 0 2
Ln_Horizon 6,710 1.757 2.258 0 0 4.248
Precision 6,710 1.13 1.491 0 0 3
Accuracy 6,710 0.957 1.621 0 0 2
Log (Assets) 6,710 5.816 1.969 4.354 5.709 7.111
Leverage 6,710 0.138 0.164 0.005 0.075 0.219
MTB 6,710 3.448 4.246 1.335 2.186 4.04
ROA 6,710 0.091 0.18 0.037 0.118 0.183
Return Volatility 6,710 0.041 0.019 0.026 0.038 0.051
Analyst Coverage 6,710 8.044 9.834 0 5 11
Institutional Ownership 6,710 0.388 0.294 0.089 0.392 0.641
Panel B: Balance Tests

Ninth Circuit States Other States
Variable n Mean SD Mean SD Diff. p-value
Disclosure Activities
Disclosure 467 0.221 0.235 0.226 0.256 0.005 0.790
Frequency 467 0.377 0.5 0.436 0.681 0.059 0.129
Ln_Horizon 467 0.847 0.976 0.956 1.179 0.109 0.124
Precision 467 0.628 0.73 0.66 0.811 0.032 0.519
Accuracy 467 0.512 0.762 0.549 0.857 0.037 0.485
Firm Characteristics
Log (Assets) 467 5.265 1.835 5.282 2.026 0.017 0.899
Leverage 467 0.108 0.134 0.109 0.124 0.001 0.949
MTB 467 3.743 3.285 4.026 3.541 0.283 0.206
ROA 467 0.100 0.168 0.106 0.158 0.006 0.550
Return Volatility 467 0.037 0.014 0.037 0.017 0.000 0.744
Analyst Coverage 467 6.161 8.278 6.73 9.506 0.569 0.330
Institutional Ownership 467 0.293 0.251 0.293 0.265 0.000 0.984
This table reports summary statistics of the main variables used in the analyses. The sample period is from 1995 to 2003, covering the four years before
and after 1999, the Ninth Circuit ruling year. Treated firms are those located in the Ninth Circuit states and are indicated by the indicator variable Ninth.
Control firms are one-to-one matched to the treated based on the average of Log (Assets), Leverage, MTB, ROA, Return Volatility, Analyst Coverage,
Institutional Ownership, and Frequency in the four years before the Ninth Circuit ruling using the propensity score matching approach. All the continuous
variables are winsorized at the 1st and 99th percentiles. Panel A presents the summary statistics, and Panel B reports the balance tests for both firm
characteristics and disclosure activities.
All the variables are defined in Appendix B.
Third, we obtain class action lawsuit filing data from the Stanford Securities Class Action Clearinghouse and estimate the
change in the number of class action cases following the 1999 ruling. Specifically, each quarter, we calculate the total number
of class action lawsuits in each circuit and examine the difference-in-differences effect of the ruling on the filing cases in the
Ninth Circuit Court relative to the other courts of appeals. Under each model in Table 3, the coefficient of the interaction term,
Ninth 3 Post1999, is significantly negative, indicating a relative decrease in the number of class action lawsuits in the Ninth
Circuit Court versus the other circuit courts after the ruling. The results are robust to excluding non-disclosure-related cases
and/or dismissed cases, which further substantiates the reduction of litigation risk for firms located in the Ninth Circuit Court
concerning their disclosure practices. These results are also robust to the circuit fixed effects and time fixed effects (in even-
numbered columns), which control for time-invariant factors specific to each circuit (e.g., legal legacy), and other regulatory
changes that occur during the same time period.

TABLE 2
Preexisting Earnings Forecast Behavior and the Ninth Circuit Ruling
(1) (2) (3) (4) (5)
Ninth
Disclosure 1.163
(0.83)
Frequency 0.603
(0.73)
Precision 0.584
(0.97)
Ln_Horizon 0.272
(0.73)
Accuracy 0.915
(1.64)
GDP Growth Rate 5.547 5.696 5.717 5.519 5.251
(0.38) (0.38) (0.40) (0.38) (0.40)
Log (GDP per Capita) 1.598 1.468 1.539 1.581 1.542
(0.83) (0.71) (0.80) (0.80) (0.86)
Log (# of Public Firms) 0.826** 0.825** 0.841*** 0.824** 0.878***
(2.52) (2.54) (2.66) (2.51) (2.75)
Constant 13.963 12.607 13.439 13.776 13.421
(0.74) (0.62) (0.72) (0.72) (0.76)
n 174 174 174 174 174
Pseudo R2 0.134 0.135 0.140 0.134 0.150
*, **, *** Denote 10 percent, 5 percent, and 1 percent significance levels, respectively.
This table reports the validity test on whether managerial disclosure behavior could predict the occurrence of the Ninth Circuit ruling. The regression
sample only includes the years before the ruling. The dependent variable is a dummy set to 1 for the Ninth Circuit states, and 0 otherwise. We consider five
disclosure variables, namely, the likelihood, frequency, horizon, precision, and accuracy of the disclosure aggregated at state-year level before the ruling.
We also control for state GDP Growth Rate, Log (GDP per Capita), and Log (# of Public Firms). The regression is estimated using a Logit model. The t-
values are shown in the parentheses.
In the odd-numbered columns in Table 3, where the model is retained with the two standalone dummies, Ninth and
Post1999, we can compare the preexisting litigation environment between the treated and the control groups. The coefficient of
Ninth is insignificant across all the specifications, which renders support for the setting validity that litigation risk shall not
differ systematically between the Ninth Circuit Court and the other circuits prior to the ruling. As further shown by the
coefficient of Post1999, there is no significant change in the litigation risk for firms in the other circuits around the timing of the
Ninth Circuit Court ruling, thereby confirming the efficacy of our classification of the treated and control group. Again, the
results are robust if we exclude dismissed cases and/or restrict the analysis to a subset of disclosure- and information-related
cases.
Baseline Effect on Earnings Forecasts

Based on the validity established in Section IV, we now exploit the exogenous decrease of litigation risk resulting from the
1999 ruling of the Ninth Circuit Court, and apply the difference-in-differences approach on the matched sample to identify its
impact on management earnings forecasts. We follow the specification in Equation (1) in Section III to carry out the analysis.
Regression results related to the tendency and frequency of earnings forecasts are summarized in Table 4. The first three
columns deliver the effect of the ruling decision on the tendency of the management making an earnings forecast (Disclosure)
based on a linear probability model. We include the standard control variables to capture the observable firm-level
characteristics that affect the intensity of management earnings forecasts, and we find results that are consistent with the prior
literature. We confirm that a firm tends to make more earnings forecasts if it is larger, followed by more analysts, and has more
shares held by institutional investors, and it makes fewer forecasts if faced with greater uncertainty. We also include firm fixed
effects in all three columns, absorbing time-invariant firm (unobservable) characteristics that may be correlated with disclosure
tendency. Standard errors are clustered at the state level where the firms were located. We include two variants of time fixed
effects. In column (1), we include year fixed effects to control for within-year correlation among firms. For example, the effect

TABLE 3
The Ninth Circuit Ruling and Class Action Lawsuits
(1) (2) (3) (4) (5) (6) (7) (8)
Log (1 þ # of Class Actions)
All Class Action Cases Disclosure- and Information-Related Cases
All Cases Excluding All Cases Excluding
Filed in the Circuit Dismissed Cases Filed in the Circuit Dismissed Cases
Ninth 3 Post1999 0.511*** 0.500** 0.464*** 0.463** 0.389*** 0.388*** 0.287*** 0.260**
(4.76) (2.78) (4.73) (2.42) (6.29) (3.39) (6.00) (2.33)
Ninth 0.218 0.226 0.145 0.150
(0.69) (0.80) (0.59) (0.75)
Post1999 0.082 0.004 0.073 0.037
(0.70) (0.03) (0.64) (0.29)
GDP Growth Rate 2.987* 3.189 1.921 1.851 3.781** 4.890* 2.013 2.225
(2.07) (1.25) (1.17) (0.64) (2.43) (1.86) (1.32) (0.82)
Log (GDP per Capita) 2.396** 4.530 2.445** 4.338 1.569* 1.627 1.459** 0.443
(2.46) (1.03) (2.70) (0.87) (2.19) (0.59) (2.43) (0.22)
Log (# of Public Firms) 1.104*** 0.021 0.948*** 0.190 0.897*** 0.738 0.767*** 0.647
(4.44) (0.01) (3.78) (0.12) (4.70) (0.68) (4.06) (0.56)
Circuit FE No Yes No Yes No Yes No Yes
Year-Quarter FE No Yes No Yes No Yes No Yes
n 352 352 352 352 352 352 352 352
Adj. R2 0.494 0.565 0.426 0.479 0.397 0.447 0.345 0.384
This table presents the effect of the Ninth Circuit ruling on the filings of class action lawsuits. The data on class actions are obtained from the Stanford
Securities Class Action Clearinghouse, which starts from 1996; hence, the sample period in this regression is from 1996 to 2003. The dependent variable is
the natural logarithm of 1 plus the number of class action lawsuits in a circuit-year. Ninth is an indicator set equal to 1 for the Ninth Circuit, and 0 for
others. Post1999 is equal to 1 for years after 1999, and 0 otherwise. Control variables include GDP Growth Rate, Log (GDP per Capita), and Log (# of
Public Firms) in a circuit-year. Columns (1) to (4) focus on all types of class action lawsuits; columns (5) to (8) focus on the lawsuits directly alleging
mishandling of disclosure and information. Circuit and year-quarter fixed effects are included in even-numbered columns. The standard errors are clustered
at the circuit level. The t-values are shown in the parentheses.
from the passage of Reg FD in 2000, which has been documented to affect corporate earnings forecast practices, can be
captured by the year fixed effect. In column (2), industry-by-year fixed effects are incorporated. This assortment of fixed effects
takes care of time-varying industry-level characteristics and mitigates the confounding effects from contemporaneous changes
at the industry level. Furthermore, we include state-specific linear trends (i.e., regional dummies interacted with a time trend) as
additional controls in column (3). They capture the overall trend of corporate disclosure at the state level, thus controlling for
unobservable factors that are correlated with regional trends, but were previously omitted. Note that we cannot include state-by-
year fixed effects, since they would subsume the interaction term, Ninth 3 Post1999, that gives us the estimate of the treatment
effect. This specification follows Moser and Voena (2012) and Atanasov and Black (2016) and it is more stringent than the
other specifications. It specifically enables us to address the issues related to the pre-ruling ‘‘parallel trend’’ assumption and to
further strengthen our identification.
The treatment effect is estimated by the coefficient associated with the interaction term (Ninth 3 Post1999). Compared to
the firms unaffected by the ruling decision, the treated firms, on average, are 6 percent less likely to generate an earnings
forecast. Columns (4) to (6) in Table 4 show the estimated effect of the ruling on the frequency of earnings forecasts
(Frequency). Based on the estimation of column (4) with firm fixed effects and year fixed effects, the treated firms, on average,
reduce 0.57 earnings forecasts compared to those not subject to the ruling decision. The empirical results are also robust to the
inclusion of industry-by-year fixed effects in column (5) and the additional incorporation of state linear trends in column (6),
suggesting that the contemporaneous events at industry-level and macro state-level factors do not account for the empirical
findings. For all the specifications, we have clustered the standard errors at the state level where the firms were located. The
results are consistent with the ‘‘litigation-deterring’’ motives of earnings forecasts. Since the treated firms would expect a lower
probability of being sued by the shareholders after the ruling, they become less incentivized to provide disclosures that are used
to prevent large stock price movements and corresponding litigation.

TABLE 4
The Effect of the Ninth Circuit Ruling on Earnings Forecast Intensity
(1) (2) (3) (4) (5) (6)
Disclosure Frequency
Ninth 3 Post1999 0.060** 0.068*** 0.066** 0.570*** 0.579*** 0.632***
(2.40) (2.86) (2.57) (3.24) (3.04) (3.18)
Log (Assets) 0.135*** 0.141*** 0.137*** 0.563*** 0.617*** 0.623***
(10.30) (10.34) (10.07) (12.83) (10.25) (9.90)
Leverage 0.011 0.013 0.011 0.829* 0.801* 0.730*
(0.14) (0.18) (0.16) (1.86) (1.84) (1.73)
MTB 0.003 0.004* 0.004** 0.005 0.001 0.002
(1.56) (1.85) (2.43) (0.47) (0.13) (0.19)
ROA 0.019 0.032 0.015 0.040 0.142 0.105
(0.44) (0.79) (0.38) (0.24) (0.80) (0.57)
Return Volatility 1.278*** 1.226*** 1.262*** 6.874*** 6.115** 6.377**
(3.58) (3.35) (3.47) (2.93) (2.07) (2.14)
Analyst Coverage 0.006*** 0.006*** 0.006*** 0.028*** 0.032*** 0.031***
(3.28) (3.87) (3.89) (2.72) (2.93) (2.80)
Institutional Ownership 0.093** 0.067* 0.061* 0.050 0.251 0.315
(2.06) (1.80) (1.69) (0.15) (0.90) (1.16)
Firm FE Yes Yes Yes Yes Yes Yes
Year FE Yes No No Yes No No
Industry 3 Year FE No Yes Yes No Yes Yes
State Linear Trend No No Yes No No Yes
n 6,710 6,710 6,710 6,710 6,710 6,710
Adj. R2 0.268 0.277 0.568 0.393 0.445 0.567
This table presents the difference-in-differences estimation of the effect of the Ninth Circuit ruling on the likelihood and frequency of earnings forecasts.
The regression sample is matched on the average of Log (Assets), Leverage, MTB, ROA, Return Volatility, Analyst Coverage, Institutional Ownership, and
Frequency in the four years before the Ninth Circuit ruling using the propensity score matching approach. The dependent variable is Disclosure in columns
(1) to (3) and Frequency in columns (4) to (6). Disclosure is an indicator variable that equals 1 if a firm makes at least one annual or quarterly earnings
forecast in the fiscal year. Frequency is the total number of annual and quarterly earnings forecasts made by a firm in a fiscal year. Ninth is equal to 1 for
firms located in the Ninth Circuit states, and Post1999 is equal to 1 for years after 1999. Different combinations of firm fixed effects, year fixed effects,
industry by year fixed effects, and state-level linear trends are included. The t-values based on the standard errors, clustered at the state level where firms
were located, are shown in the parentheses.
Definitions of all other variables are contained in Appendix B.
Next, we explore how the ruling affects earnings forecast properties. We use two versions of forecast properties for the
analysis, and present the results under the more stringent specification with firm fixed effects, industry-by-year fixed effects,
and linear state trends in Table 5. The first version is based on the baseline sample, where the forecast properties are assigned a
value of 0 in the years when firms make no earnings forecasts. As mentioned in Section III, we can reduce the bias from sample
truncation when forecast properties are constructed in a way that incorporates the first-order issuance decision at the extensive
margin. The results using the baseline sample are shown in columns (1) to (3). We find that the ruling decision reduces the
average forecast horizon by 31.3 percent for the treated firms in relation to the control firms, which can be contributed by firms
either postponing or suspending earnings forecasts. Forecast precision and accuracy of the treated firms also reduce relatively
against the control firms after the ruling based on the sample with both the extensive and intensive margin.
We then focus on the restricted sample, where only firm-years with at least one earnings forecast are included. This version
removes the first layer of decision on forecast issuance from the construction of forecast properties, but retains the secondary
decision on the manners of making forecasts at the intensive margin within the forecast sample. The results are shown in Table
5, columns (4) to (6). We find that firms do not further change the timing of earnings forecasts around the ruling when they
have already decided to issue a forecast, which suggests that the effect of the ruling on forecast horizon is mainly contributed by
the decreased intensity to issue a forecast (i.e., a decision at the extensive margin). However, there is some weak evidence that
the treated firms reduce the precision and accuracy of the earnings forecasts they issue when they are faced with a more lenient
litigation environment compared to the control firms. While these findings shed some light on the role that these secondary
decisions provide in forming a forecast to deter litigation, we demonstrate below that these results are not robust. Therefore, we

TABLE 5
The Effect of the Ninth Circuit Ruling on Earnings Forecast Properties
(1) (2) (3) (4) (5) (6)
Baseline Sample Forecast Sample
Ln_Horizon Precision Accuracy Ln_Horizon Precision Accuracy
Ninth 3 Post1999 0.313** 0.248*** 0.256*** 0.093 0.266* 0.430*
(2.17) (2.96) (3.06) (0.49) (1.78) (1.80)
Log (Assets) 0.650*** 0.393*** 0.361*** 0.155* 0.045 0.142
(9.79) (8.41) (8.11) (1.81) (0.62) (1.04)
Leverage 0.218 0.152 0.587** 0.685* 0.458 0.925*
(0.69) (0.57) (2.06) (1.84) (1.42) (1.71)
MTB 0.013 0.008 0.006 0.014 0.002 0.008
(1.42) (1.49) (1.12) (1.34) (0.24) (0.47)
ROA 0.031 0.116 0.108 0.002 0.850*** 1.471***
(0.16) (0.98) (1.16) (0.00) (2.91) (2.71)
Return Volatility 4.109** 3.817*** 4.657*** 2.848 4.139 14.581***
(2.35) (4.14) (3.46) (0.84) (1.65) (3.77)
Analyst Coverage 0.023*** 0.019*** 0.022*** 0.020** 0.003 0.004
(2.92) (2.93) (2.93) (2.46) (0.37) (0.35)
Institutional Ownership 0.289 0.175 0.208 0.334 0.116 0.549
(1.42) (1.34) (1.29) (1.60) (0.55) (1.47)
Industry 3 Year FE Yes Yes Yes Yes Yes Yes
State Linear Trend Yes Yes Yes Yes Yes Yes
n 6,710 6,710 6,710 2,695 2,695 2,695
Adj. R2 0.577 0.546 0.470 0.964 0.936 0.747
This table presents the difference-in-differences estimation of the effect of the Ninth Circuit ruling on the properties of earnings forecasts. Columns (1) to
(3) are based on our baseline sample as used in Table 4. Ln_Horizon is natural logarithm of 1 plus average horizon of all the annual and quarterly earnings
forecasts made by a firm in a fiscal year. For each forecast, horizon is the number of calendar days between the forecast announcement date and the
forecast period end date. Precision is the average score of precision for all the annual and quarterly earnings forecasts made by a firm in a fiscal year: we
assign a score of 0 if no estimates are made, 1 for qualitative estimates, 2 for open estimates, 3 for range estimates, and 4 for point estimates. Accuracy is
the average score of accuracy for all the annual and quarterly earnings forecasts made by a firm in a fiscal year. We first calculate the absolute difference of
the forecast and actual earnings, scale the difference by the stock price at the end of the previous month, and sort the scaled difference into quintiles. We
then assign a score of 1 if the forecast has the largest error (top quintile), 2 if the forecast is in the second quintile, 3 if the forecast is in the third quintile, 4
if the forecast is in the fourth quintile, 5 if the forecast is in the bottom quintile, and 0 if no forecasts are made. Columns (4) to (6) are based on a sample of
firm-years with at least one management forecast; that is, the value of 0 is removed from these property measures in this version. Different combinations of
firm fixed effects, year fixed effects, industry by year fixed effects, and state-level linear trends are included. The t-values based on the standard errors,
clustered at the state level where firms were located, are shown in the parentheses.
focus on the intensity of earnings forecasts, which reflects the first-order decision in a firm’s disclosure policy, for the
subsequent analysis.20
To further validate the causal relation between litigation risk and earnings forecast intensity, we perform two additional
tests that exploit the time-series and cross-sectional variations of the relation, respectively. First, we trace the dynamic effect of
the ruling decision on earnings forecasts’ intensity. Using Frequency of earnings forecasts for illustration, we plot the average
frequency of earnings forecasts made by the treated and control firms, respectively, against the sample period from 1995 to
2003 in Panel A of Figure 1. Several patterns are depicted by the plots in Figure 1. First, there is no significant difference in
forecast intensity between the treated and control firms prior to the 1999 ruling, which is consistent with the comparative
statistics in Table 1 and lends more support to the ‘‘parallel trend’’ assumption for the difference-in-differences analysis.
Second, forecast intensity of the two groups starts to diverge after the 1999 ruling—the increasing trend of earnings forecasts
slows down for the treated firms compared to the trend in the control group, which again supports the ruling’s relative negative
20
In Table A1 of the Online Appendix (see Appendix C for the link to the downloadable file), we have also examined the ruling’s effect on the directional
bias of earnings forecasts, in addition to the absolute accuracy with respect to actual earnings. We have not found any significant effect.

FIGURE 1
The Ninth Circuit Ruling and Management Earnings Forecasts
The figure plots the level of earnings forecast intensity before and after the Ninth Circuit ruling. Panel A presents the average forecast frequency over the
years. Panel B presents the difference in average forecast frequency between treated firms and control firms over the years.
effect on management earnings forecasts. Third, this negative effect materializes within two years after the ruling decision and
persists for at least two more years. In Panel B of Figure 1, we plot the difference of average forecast frequency between the
treated and control firms against each year in the sample period. The plot also illustrates that the forecast intensity of the two
groups are not different from each other prior to the ruling in 1999, but differences arise afterward. In 2002, for example, the
average number of earnings forecasts made by the treated firms is one forecast fewer than that of the control firms, whereas the
difference is close to zero before the ruling. The two plots suggest that the ruling has a sustained negative causal impact on
management earnings forecasts—when the ruling has rendered the litigation environment more lenient for the firms in the
Ninth Circuit, they become less incentivized to provide voluntary disclosure in the form of management earnings forecasts.
Second, we examine the heterogeneous effects of the ruling on the earnings forecasts of firms with different pre-ruling
litigation propensity. Since the ruling lowering litigation risk reduces the earnings forecasts of the treated firms, we expect the
reduction to be stronger if the treated firms were previously operating in a highly litigious environment. Our measure of the pre-
ruling industry-level litigation propensity is the number of firms with class action lawsuits before the Ninth Circuit ruling
divided by the total number of firms in that industry. We then divide the treated firms into High Litigation Propensity and Low
Litigation Propensity groups based on the sample median of the litigation propensity measure, and define two separate
dummies to tag them, namely, Ninth (High Litigation Propensity) and Ninth (Low Litigation Propensity). We interact the two
treatment dummies with Post1999 and substitute them for the original interaction term Ninth 3 Post1999 in Specification (1).
The results are presented in Table A2 of the Online Appendix. The coefficients of Ninth (High Litigation Propensity) 3
Post1999 all take on significant negative signs, whereas those of Ninth (Low Litigation Propensity) 3 Post1999 are mostly
insignificant. We also find that the difference in the magnitude between the two groups of coefficients is significantly negative,
as shown by the p-value of the test statistic. These results suggest that the ruling has a greater effect on the firms with higher
litigation propensity prior to the ruling. Since these firms are more susceptible to litigation, the heightened pleading standards
should reduce their litigation concerns more than other firms, thereby further reducing their incentives to provide earnings
forecasts. Altogether, the baseline, dynamic, and channel tests confirm the positive relation between litigation risk and earnings
forecasts.
Differential Effects on Positive and Negative News Forecasts

In this section, we will separately explore the effect of litigation risk on the disclosure of positive news forecasts and
negative news forecasts. We will build on the baseline effect identified in the previous sections and develop a hypothesis that
distinguishes the ruling’s effect on the two types of earnings forecasts.

According to Skinner (1994), firms face an asymmetric loss function regarding securities class actions. Specifically,
securities class actions are commonly triggered by a large stock price decline, which tends to be associated with inadequate or
untimely disclosure of adverse information. By contrast, we would not expect large price increases (which are attributed to
omissions in disclosing positive news) to trigger legal action. There are two reasons why a large price increase due to
previously insufficient disclosure of good news is less likely to bring about litigation. For one thing, shareholders, who claim to
sell the shares due to untimely disclosure of good news forecasts, can hardly justify the opportunity cost of not holding the
shares as damage; for another, shareholders find it hard to prove that they would not have sold the shares if positive news had
been provided to them. Therefore, as inadequate or untimely disclosure of negative news is of greater litigation concerns for
firms than omitting positive news, we hypothesize that the treated firms will have a greater reduction in the likelihood and
frequency of earnings forecasts after the Ninth Circuit ruling if they possess negative news versus positive news (in relation to
the unaffected firms).
To test the hypothesized effect on the two types of forecasts, we employ the same set of estimation methods for positive
news and negative news forecasts. As illustrated in Section III, positive news and negative news forecasts are defined,
respectively, as forecasts above and below the prevailing analyst consensus adjusted for any bundling effect during the time
period, following Rogers and Van Buskirk (2013). We perform the analysis using the more stringent specification in Equation
(1) in Section III, where firm fixed effects, industry-by-year fixed effects, and state linear trends are included. Discit is evaluated
as one of the two intensity measures of earnings forecasts separately constructed for positive news and negative news. As can
be seen from Table 6, neither coefficient associated with the interaction (Ninth 3 Post1999) related to the forecasts of positive
news is statistically significant; yet the corresponding coefficients related to the forecast of negative news are significantly
negative. We further test the difference between the treatment estimates for the disclosure of positive versus negative news
forecasts using the Seeming Unrelated Regression (SUR) model, and find them statistically and significantly different. The
results suggest that negative news forecasts made by the treated firms decline significantly more relative to the control sample,
while the changes in positive news forecasts are not different between the two groups. This evidence confirms the prediction
from our hypothesis and is consistent with Skinner’s (1994) claim that the loss functions governing disclosure practices are
asymmetric, and that voluntarily disclosing negative news helps deter litigation.
We also examine the impact of the ruling on the bias of earnings forecasts conveying positive and negative news,
respectively. As shown in Table A1 of the Online Appendix, the ruling does not have a significant effect on the bias of earnings
forecasts conditional on their news content, which is consistent with the unconditional results on forecast bias.
Robustness Check
In this section, we conduct a battery of robustness tests to confirm the findings. First, we are concerned that the results may
still be driven by certain omitted variables that are not well captured by the assortment of fixed effects and the state linear trends
in our previous specification. If the Ninth Circuit ruling and management forecast decisions are correlated with these variables,
then our results can be biased. Therefore, we include two additional firm-level controls and a series of state-level economic
factors to the baseline regressions. Loss is an indicator variable set equal to 1 when a firm has negative earnings. It is a binary
measure of a firm’s profitability status, in addition to the continuous ROA measure that was used in our original specification.
Analyst Dispersion is the standard deviation of the earnings estimates provided by the analysts covering the firms. It measures a
firm’s degree of information asymmetry, which is correlated with management forecast decisions (e.g., Lennox and Park 2006).
We also incorporate economic factors such as Log (GDP per Capita) and GDP Growth Rate at the state level where a firm is
located, because the Ninth Circuit Court mainly covers the states in the west of the U.S. and the economic conditions specific to
the region may confound the results. We present the results in columns (1) and (2) in Panel A of Table 7. As state-level factors
are explicitly controlled, we include the basic firm fixed effects and year fixed effects in the regressions. We find that the
decrease in the likelihood and frequency of management earnings forecasts is robust to the additional controls; thus, the results
are unlikely to be driven by the overall profitability and information environment of the firm or the level of regional economic
development.
We are also concerned about the confounding effect of a few specific contemporaneous events. The bursting of the internet
bubble, for example, is one such event that occurred during our sample period. As disclosure may be highly correlated with
growth (Khurana, Pereira, and Martin 2006), the boom and bust of high-tech industry around 2000 may provide an alternative
explanation for the decrease in earnings forecasts given the nontrivial proportion of high-tech firms in our treated sample. This
concern is particularly relevant for Silicon Valley firms located in California. While the results are robust to controlling for
industry-by-year fixed effects, state-specific linear time trends, and additional state-level macro factors, it cannot completely
mitigate the confounding effect of the tech-bubble burst that can affect high-tech firms across states and years. Thus, we check
whether the results are robust to the exclusion of high-tech firms. Columns (3) and (4) of Panel A in Table 7 present the results
where high-tech firms are excluded. We define high-tech firms as those operating in electrical equipment and drugs industries

TABLE 6
Differential Effects of the Ninth Circuit Ruling on Earnings Forecasts of Good versus Bad News
(1) (2) (3) (4)
Positive Negative Positive Negative
Ninth 3 Post1999 0.028 0.059** 0.142 0.335***
(1.11) (2.33) (1.41) (3.31)
Log (Assets) 0.088*** 0.089*** 0.217*** 0.274***
(9.46) (6.21) (5.99) (7.13)
Leverage 0.133*** 0.039 0.635*** 0.185
(2.71) (0.49) (3.25) (0.85)
MTB 0.001 0.001 0.002 0.004
(0.88) (1.22) (0.37) (0.83)
ROA 0.067** 0.059* 0.194 0.249***
(2.42) (1.92) (1.65) (3.61)
Return Volatility 0.324 1.277*** 1.652 4.483***
(1.02) (3.31) (1.04) (2.82)
Analyst Coverage 0.001 0.008*** 0.013** 0.024***
(0.81) (5.26) (2.48) (4.51)
Institutional Ownership 0.111** 0.025 0.015 0.163
(2.37) (0.64) (0.10) (1.25)
Firm FE Yes Yes Yes Yes
Industry 3 Year FE Yes Yes Yes Yes
State Linear Trend Yes Yes Yes Yes
n 6,710 6,710 6,710 6,710
Adj. R2 0.436 0.460 0.400 0.445
p-value H0: Positive Negative 0.05 0.0013
This table presents the difference-in-differences estimation of the effect of the Ninth Circuit ruling on the earnings forecasts conveying different news. The
regression sample is matched on the average of Log (Assets), Leverage, MTB, ROA, Return Volatility, Analyst Coverage, Institutional Ownership, and
Frequency in the four years before the Ninth Circuit ruling using the propensity score matching approach. We classify forecast news as positive (negative)
following Rogers and Van Buskirk (2013), and construct the dependent variables separately for the positive news forecasts and negative news forecasts.
Firm fixed effects, industry by year fixed effects, and state-level linear trends are included. The t-values based on the standard errors, clustered at the state
level where firms were located, are shown in the parentheses. The coefficients of Ninth 3 Post1999 associated with positive and negative news forecasts in
column (1) versus (2) and (3) versus (4) are tested using SUR estimation, with p-value reported in the last row.
Definitions of all other variables are in Appendix B.
based on the Fama-French 48 industry classifications, plus the internet firms identified in Hand (2000). As shown by the
coefficients of the interaction terms, the results are robust to excluding high-tech firms, and the magnitude of the estimated
effect is similar to the baseline findings.
Moreover, we restrict the sample to a group of consistent forecasters to address the selection issue resulting from the
bursting of the internet bubble. Specifically, there are concerns that the composition of firms in the Ninth Circuit states may
change after the ruling due to shutdowns and mergers of technology firms following the internet bubble burst, leading us to
observe a different pattern of disclosure practices for the treated firms from the firms in the other states. Therefore, besides the
requirement in the main tests that financial variables are available for firms both prior to and after the ruling, we further require
the firms to have earnings forecast records available before the ruling. As shown in columns (5) and (6) of Panel A in Table 7,
the results are robust to the sample of consistent forecasters—both the likelihood and frequency of management earnings
forecasts decrease significantly after the Ninth Circuit ruling among the treated firms versus the control firms. We also restrict
the sample to quarterly earnings forecasts and redo the analysis at the quarterly level within a shorter window to reduce the
likelihood that contemporaneous events are confounding our results. We focus on the two years before and the two years after
the ruling (1997–2001). We redefine all the control variables at the quarterly level and construct the quarterly sample using the
same propensity score matching approach as in our main tests. The results remain robust and are shown in columns (7) and (8)
of Panel A in Table 7.

TABLE 7
Robustness Results
Panel A: Additional Confounding Factors and Events
(1) (2) (3) (4) (5) (6) (7) (8)
Additional Firm-Level Exclude Quarterly Sample

and State-Level Factors High-Tech Firms Consistent Forecasters with Shorter Window

Disclosure Frequency Disclosure Frequency Disclosure Frequency Disclosure Frequency
Ninth 3 Post1999 0.068** 0.654*** 0.067** 0.554*** 0.071** 0.629** 0.032** 0.060***
(2.20) (3.16) (2.53) (2.71) (2.35) (2.15) (2.41) (2.80)
Log (Assets) 0.110*** 0.452*** 0.143*** 0.660*** 0.143*** 0.704*** 0.067*** 0.087***
(6.97) (6.07) (9.28) (8.73) (7.82) (9.30) (5.26) (5.46)
Leverage 0.192* 0.548 0.001 0.694 0.003 1.243** 0.080* 0.146**
(1.88) (1.09) (0.02) (1.67) (0.03) (2.58) (1.69) (2.15)
MTB 0.002 0.008 0.006** 0.003 0.003 0.002 0.005*** 0.007***
(1.02) (0.53) (2.57) (0.28) (1.58) (0.12) (3.94) (3.30)
ROA 0.027 0.417 0.054 0.096 0.036 0.242 0.591*** 0.832***
(0.36) (1.44) (1.08) (0.51) (0.60) (0.93) (5.91) (4.64)
Return Volatility 0.335 11.512** 1.091*** 5.187 1.381*** 10.602*** 0.612** 0.819**
(0.50) (2.54) (2.70) (1.55) (2.96) (3.47) (2.23) (2.13)
Analyst Coverage 0.005** 0.019 0.006*** 0.030*** 0.007*** 0.035** 0.011*** 0.016***
(2.36) (1.67) (3.51) (3.21) (3.59) (2.33) (6.55) (5.21)
Litigation Risk and Voluntary Disclosure: Evidence from Legal Changes
Institutional Ownership 0.033 0.902** 0.074* 0.133 0.006 0.820** 0.011 0.031
(0.60) (2.37) (1.70) (0.46) (0.11) (2.42) (0.38) (0.56)
Loss 0.046** 0.325**
(2.28) (2.68)
Analyst Dispersion 0.005* 0.037**
(1.72) (2.11)
Log (GDP per Capita) 0.319 1.904*
(1.49) (1.85)
GDP Growth Rate 0.156 2.658
(0.57) (1.29)
Firm FE Yes Yes Yes Yes Yes Yes Yes Yes
Year/Year-Quarter FE Yes Yes No No No No No No
Industry 3 Year FE No No Yes Yes Yes Yes Yes Yes
State Linear Trend No No Yes Yes Yes Yes Yes Yes
n 5,213 5,213 6,254 6,254 4,792 4,792 12,728 12,728
Adj. R2 0.259 0.409 0.565 0.563 0.591 0.592 0.300 0.283
(continued on next page)
263
TABLE 7 (continued)
264
Panel B: Issues with Control Group and Outcome Variables

(1) (2) (3) (4) (5) (6) (7) (8)
Matched Sample with
Exclude IPO firms the Second Circuit Firms Exclude Firms Sued Voluntary 8-K Filing
Disclosure Frequency Disclosure Frequency Disclosure Frequency No_8K Abs_CAR_8K
Ninth 3 Post1999 0.063** 0.643** 0.061** 0.067 0.077** 0.676*** 0.176** 0.040*
(2.29) (2.57) (2.55) (0.56) (2.62) (3.09) (2.14) (2.01)
Log (Assets) 0.124*** 0.568*** 0.109*** 0.604*** 0.147*** 0.644*** 0.313*** 0.006
(7.69) (9.64) (6.45) (5.20) (9.02) (8.19) (5.59) (0.62)
Leverage 0.068 0.819* 0.010 0.355 0.017 0.924* 0.244 0.102
(0.88) (1.84) (0.06) (0.77) (0.23) (1.95) (1.24) (1.54)
MTB 0.004 0.006 0.003 0.007 0.004** 0.003 0.002 0.000
(1.52) (0.53) (1.20) (0.57) (2.12) (0.33) (0.60) (0.10)
ROA 0.019 0.136 0.031 0.051 0.030 0.131 0.338*** 0.019
(0.40) (0.66) (0.81) (0.25) (0.69) (0.57) (2.73) (0.70)
Return Volatility 0.983 4.522 0.919*** 4.896 0.832** 5.429 4.410*** 0.131
(1.65) (1.46) (3.39) (1.10) (2.12) (1.60) (3.46) (0.35)
Analyst Coverage 0.008*** 0.038*** 0.010*** 0.038* 0.005*** 0.017 0.004 0.000
(3.99) (2.77) (4.35) (1.98) (3.01) (1.53) (0.63) (0.04)
Institutional Ownership 0.008 0.438 0.187*** 0.610 0.051 0.120 0.342* 0.055
(0.17) (1.55) (4.71) (1.60) (1.31) (0.44) (1.68) (1.28)
Firm FE Yes Yes Yes Yes Yes Yes Yes Yes
Industry 3 Year FE Yes Yes Yes Yes Yes Yes Yes Yes
State Linear Trend Yes Yes Yes Yes Yes Yes Yes Yes
n 5,780 5,780 4,685 4,685 6,196 6,196 10,900 4,877
Adj. R2 0.572 0.575 0.556 0.550 0.562 0.569 0.571 0.495
This table presents robustness checks. In Panel A, columns (1) and (2) report the results controlling for additional firm-level and state-level factors. Loss is an indicator equal to 1 if earnings is negative.
Analyst Dispersion is the standard deviation of the analyst forecasts scaled by the mean consensus. Log (GDP per Capita) is defined as the natural logarithm of the ratio of current GDP over total
population in a state. GDP Growth Rate is defined as the growth rate of GDP in the current year relative to the previous year. Columns (3) and (4) present the results excluding high-tech firms, where
high-tech firms are categorized as electrical equipment and drugs in the Fama-French 48 industry classifications, plus internet firms identified in Hand (2000). Columns (5) and (6) present the results
estimated using a sample of consistent forecasters that started to issue earnings forecasts prior the ruling. Columns (7) and (8) present the baseline results using a firm-quarter-year sample. The sample is
restricted to the two years before and two years after the ruling year. In Panel B, columns (1) and (2) present the results excluding IPO firms, so that only firms having already been listed before 1995 are
included in the sample. Columns (3) and (4) use an alternative sample matched using firms in the Second Circuit using the propensity score matching approach. Columns (5) and (6) present the results
excluding firms that were sued by shareholders through a class action prior to the ruling. Columns (7) and (8) present the effect of the Ninth Circuit ruling on firms’ voluntary 8-K filing activities. We
identify an 8-K filing as voluntary if it contains the items labeled as ‘‘Other Events.’’ No_8K is the number of voluntary 8-K forms a firm filed with the SEC in a year. Abs_CAR_8K is the aggregated
absolute value of the three-day cumulative abnormal return to voluntary 8-K filings of a firm in a year, where abnormal return is estimated using a market model. The t-values based on standard errors,
clustered at the state level where firms were located, are shown in the parentheses.

Houston, Lin, Liu, and Wei

Second, we deal with the issue that the control group might be contaminated during our event window. For instance, there
is a surge of IPO lawsuits in 2001 in the control group (mainly in the Second Circuit Court). If higher litigation risk leads to
stronger disclosure, then our results could be generated by an increase of earnings forecasts in the control group, rather than a
decrease in the treated group that we have claimed to be associated with the reduction of litigation risk in the Ninth Circuit
Court. In an unreported validity test on the change in the number of class action lawsuits following the Ninth Circuit Court
ruling, similar to those presented in Table 3, we exclude the class action lawsuits filed in the Second Circuit Court and confirm
the decrease in the class action lawsuits filed in the Ninth Circuit Court. This test addresses the concerns that the relative
reduction of cases documented for the Ninth Circuit Court may be driven by an abnormal increase of IPO allocation lawsuits in
2001 in the Second Circuit Court as one of the controlling circuits.21 We further address the problem by dropping all the IPO
firms from our sample. We identify IPO firms as those that appeared in the Compustat database for the first time within our
sample period.22 In columns (1) and (2) of Panel B in Table 7, we find a quantitatively similar effect of the ruling on the
intensity of earnings forecasts when the IPO firms are excluded.
Related to the litigation environment of the control group, Cazier et al. (2016) point out that the Second Circuit maintains a
relatively constant interpretation of the pleading standards during our sample period compared to the other circuits in the
control group. Therefore, we implement the difference-in-differences design on a matched sample with the Second Circuit firms
based on the nearest propensity score. Due to the small number of firms located in the Second Circuit states, we end up with a
smaller matched sample consisting of 4,685 firm-years.23 We then apply the more stringent specification in Equation (1) to the
newly matched sample and reestimate the effect of the ruling. The results are summarized in columns (3) and (4) of Panel B in
Table 7. Again, we document a significant decrease in the disclosure of earnings forecasts among the treated firms in relation to
the control firms after the ruling. Therefore, our findings are unlikely to be driven by the changes in the litigation environment
in the controlling circuits.
Third, different preexisting litigation status between the treated and control firms may also confound the results. According
to Rogers and Van Buskirk (2009), firms are less likely to provide earnings forecasts if they were previously targeted by
lawsuits. Thus, if the firms located in the Ninth Circuit states faced greater litigation than other firms prior to the ruling, we may
document a spurious negative relation between the ruling and earnings forecast behaviors of the treated firms compared to the
control firms. The test in Table 3 helps address the concern to some extent, as the evidence suggests no difference in the number
of class action lawsuits between the Ninth Circuit and other circuits before the ruling. To further address the concern, we
exclude the firms that were sued before the ruling from the sample and reassess the relation. The results are presented in
columns (5) and (6) in Panel B of Table 7. The effect of the ruling remains significantly negative on the intensity of earnings
forecasts. Therefore, the causal relation we established in the baseline analysis cannot be explained by any preexisting
differences of litigation experiences between the treated and control firms.
Finally, we address the concerns related to the coverage of FCHD that provides data on management earnings forecasts.
According to Anilowski, Feng, and Skinner (2007) and Chuk, Matsumoto, and Miller (2013), the coverage of FCHD became
more systematic and complete after 1997; thus, a firm may enter our sample after the ruling due to improved coverage of the
database rather than changes in its disclosure policy (from non-disclosure to disclosure). While this issue tends to bias against
our (negative) results because it will lead to a mechanical increase in the disclosure frequency of the newly covered firms, we
have shown that the results hold when we restrict the sample to a group of consistent forecasters who had started earnings
forecasts prior to the Ninth Circuit ruling (see columns (5) and (6) of Table 7, Panel A). We also construct alternative measures
of voluntary disclosure to address the issue. Specifically, we collect information on 8-K filings from the SEC’s EDGAR, which
is another important channel for firms to disclose information to the public. Following Boone and White (2015), we identify the
voluntary 8-K filings that contain the items labeled as ‘‘Other Events,’’ under which the managers have discretion to disclose
information, including earnings forecasts, voluntarily to the shareholders. We calculate the number of voluntary 8-K filings
(No_8K) filed by a firm in a year and measure the information content of the filings (Abs_CAR_8K) by aggregating the absolute
value of the three-day cumulative abnormal returns (CARs) of the filings in a firm-year. A market model is used to estimate the
daily abnormal return for each filing. Following the same propensity score matching approach, we obtain a sample of 10,900
firm-years and reapply the more stringent regression specification in Equation (1) to the alternative measures. We present the
results in the last two columns in Panel B of Table 7. As with the baseline analysis, we find that the frequency and information
21
There is a large surge of IPO lawsuits in 2001 (see, for example, Hanley and Hoberg 2012), and most of them are likely to be filed in the Southern
District of New York, the Second Circuit Court (Bohn and Choi 1996).
22
Specifically, we focus on the firms that have Compustat records before 1995. Since Compustat may contain the financial data for a firm even before the
IPO year, we also check the results using a sample of firms with the first appearance in Compustat before 1993, and the results are robust.
23
There may be common support concern due to the small number of firms in the Second Circuit. Therefore, this alternative control group is not used for
our main analysis.

content of voluntary 8-K filings decrease after the Ninth Circuit ruling among the treated firms compared to the control firms,
which is consistent with the ‘‘litigation-deterring’’ motives of voluntary disclosure.
Additional Legal Events

In this section, we use two additional legal events to confirm the baseline findings. The first is a reversal decision on the
pleading standards by the Supreme Court. As introduced in Section II, the ruling decision reversed the relatively stringent
pleading standards in the Ninth Circuit Court, leading to an increase of litigation risk for firms in the region. We then use this
reversal event to examine firms’ responses in their earnings forecasts.
As with the baseline analysis, we restrict the sample period to 2003 to 2011, which includes the four years before and after
the 2007 Supreme Court decision. Once again, we use propensity score matching and obtain a total of 6,346 firm-years based
on the average value of firm size, leverage, MTB ratio, ROA, return volatility, analyst coverage, institutional ownership, and
earnings forecast frequency over 2002 to 2006, the pre-decision period. The Ninth Circuit firms are matched with the firms in
all other circuits except the First, Fourth, and Sixth Circuits, because their pleading standards are also likely to be reduced by
the Supreme Court decision (Choi and Pritchard 2012). We then follow the three regression specifications in Equation (1) to
conduct the analysis.
Panel A of Table 8 summarizes the results based on the Supreme Court’s decision of Tellabs. We find a significant increase
in both the likelihood and frequency of earnings forecasts among the treated firms in relation to the control firms after the
Supreme Court decision. The magnitude of the increase is similar to the reduction following the 1999 ruling, but may not
completely offset it. On one hand, the precedent-setting decision by the Supreme Court is not always followed by the circuit
courts (Westerland, Segal, Epstein, Cameron, and Comparato 2010). On the other hand, the Supreme Court has been shown to
have limited attention on securities class actions at the circuit level; thus, they rarely review or reverse them (Pritchard 2011).
For either reason, the Ninth Circuit Court may not fully bounce back to the pre-1999 litigation environment, yet the reversal
change in the intensity of earnings forecasts is large enough to confirm our baseline findings.
Next, we supplement the Ninth Circuit Court ruling with another legislative change. We refer to the recent studies that
explore the amendment of Nevada corporate law and its consequences (Barzuza 2012; Barzuza and Smith 2014; Donelson and
Yust 2014). Unlike the previous two legal changes, the reform of Nevada corporate law applies to the firms incorporated in
Nevada; thus, they are not necessarily located in the state. In 2001, Nevada unilaterally took steps to limit the legal liability of
directors and officers, so that they can only be held liable when their behaviors involve a breach of the duty of loyalty and
intentional misconduct, fraud, or a knowing violation of law simultaneously (Barzuza 2012). Relative to managers in the other
states, Nevada executives are now protected by higher pleading standards on all types of securities actions following this
amendment. We, thus, employ this legal change as another quasi-natural experiment to test the links between litigation risk and
management earnings forecasts.
We restrict the sample period to 1997 to 2005, covering the four years before and after the corporate law amendment in
2001. This ruling applies to all the firms incorporated in Nevada, where a total of 39 treated firms are available with required
variables for matching. For each treated firm, we identify five control firms that rank the highest by the propensity score
estimated from the average value of firm size, leverage, MTB ratio, ROA, return volatility, analyst coverage, institutional
ownership, and forecast intensity in the pre-event period. Again, we follow the three specifications in Equation (1) to conduct
the analysis. The difference-in-differences estimates on management forecast measures are presented in Panel B of Table 8.
Since the reform occurs in the incorporation state of the firms, the standard errors are also clustered at the same level. We find
that after the legislative change, Nevada-incorporated firms issue fewer management forecasts than the control firms. The
results generate the same conclusion that we draw from our main tests related to the Ninth Circuit ruling decision.
V. CONCLUDING REMARKS
In this paper, we have shown that shifts in the litigation environment can cause firms to change their disclosure practices—
lower litigation risk reduces the likelihood and frequency of earnings forecasts, especially for those conveying negative news.
The findings shed new light on the longstanding debate concerning the relation between expected litigation risk and corporate
voluntary disclosure.
In order to establish a causal relation, we utilize three legal changes that generate exogenous shocks to the level of
litigation risk, and we focus on the 1999 ruling decision by the Ninth Circuit Court (Silicon Graphics case), which reduces
litigation risk for firms located in the Ninth Circuit. Using a matching-based fixed-effect difference-in-differences approach, we
document that the treated firms become less likely to issue earnings forecasts compared to the control firms, and the average
frequency of the forecasts also becomes lower. These results are in line with Skinner’s (1994) contention that firms voluntarily
make earnings forecasts to deter litigation, and they help resolve the inherent controversies that surround the various effects of
the rules governing securities fraud.

TABLE 8
Litigation Risk and Management Earnings Forecasts: Evidence from Additional Legal Events
Panel A: Supreme Court Decision on Tellabs in 2007

(1) (2) (3) (4) (5) (6)
Ninth 3 Post2007 0.057** 0.070*** 0.067** 0.364** 0.314* 0.289*
(2.48) (2.95) (2.63) (2.06) (2.00) (1.80)
Controls Yes Yes Yes Yes Yes Yes
n 6,346 6,346 6,346 6,346 6,346 6,346
Adj. R2 0.600 0.605 0.807 0.657 0.662 0.783
Panel B: Nevada Corporate Law Change in 2001

(1) (2) (3) (4) (5) (6)
Nevada 3 Post2001 0.151*** 0.190*** 0.170*** 0.929*** 1.170** 1.199***
(6.23) (8.08) (5.20) (3.77) (2.06) (3.48)
Controls Yes Yes Yes Yes Yes Yes
n 1,756 1,756 1,756 1,756 1,756 1,756
Adj. R2 0.319 0.322 0.344 0.486 0.484 0.516
This table presents the impact of litigation risk on earnings forecasts using additional legal events. Panel A presents the effect of the Supreme Court
decision on the case Tellabs, Inc. v. Makor Issues & Rights, which effectively increases litigation risk for firms located in the Ninth Circuit Court. The
sample is from 2003 to 2011, spanning the four years before and after the Supreme Court’s decision. Ninth is an indicator equal to 1 for firms located in the
Ninth Circuit, and 0 otherwise. Post2007 is equal to 1 for years after 2007. Panel B presents the effect of the Nevada corporate law amendment in 2001,
which decreases litigation risk for firms incorporated in Nevada. The sample period is from 1997 to 2005, covering the four years before and after the law
amendment. Nevada is an indicator variable that equals 1 if a firm is incorporated in Nevada, and 0 otherwise. Post2001 is equal to 1 for years after 2001.
Different combinations of firm fixed effects, year fixed effects, industry by year fixed effects, and state-level linear trends are included. The t-value based
on standard errors, clustered at the state level where firms were located (Panel A) or incorporated (Panel B), are shown in the parentheses. The t-values
based on the standard errors clustered at the operating (Panel A) and incorporation (Panel B) state level, respectively, are shown in the parentheses.
Definitions of all other variables are in Appendix B.
In view of the asymmetric loss function faced by managers, we also disentangle the ruling’s effects on positive news
forecasts and negative news forecasts. We find that the reduction of voluntary disclosure is primarily driven by the decrease in
negative news forecasts. That is to say, it is inadequate disclosure of negative news that matters more for litigation issues.
Finally, we conduct an assortment of robustness tests to strengthen the causal relation between litigation risk and voluntary
disclosure. The results are robust to additional controls, confounding events, and alternative disclosure measures.
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APPENDIX A
Two Examples of Disclosure-Related Class Action Lawsuits
Example One
Defendant: Paracelsus Healthcare Corporation
Filing Date: October 15, 1996
The federal consolidated complaint alleged violations of Federal securities laws. More specifically, the complaint
alleged that during the class period, the named defendants disseminated materially misleading statements and omitted
disclosing material facts about the Company and its business, specifically in the reporting and disclosure of reserves,
bad debt expenses, collection expenses and facility closure costs and that the price of the Company’s common stock
was artificially inflated. The plaintiffs also alleged that the named defendants failed to make a reasonable investigation
and did not possess reasonable grounds for the belief that the statements contained in the various registration
statements and prospectuses filed during the class period were true, or that there was an omission of material facts
necessary to make the statements contained therein not misleading.
The original complaint alleged that Paracelsus, certain of its officers and directors, Bear Stearns & Co., Inc., Smith
Barney, Inc., and The Chicago Corporation, certain lead underwriters of Paracelsus’s Aug. 13, 1996 offering of 4.6
million shares of common stock, with violations of the federal securities laws (Sections 11, 12(2) and 15 of the
Securities Act of 1933), common law, and Texas securities laws, by among other things, misrepresenting and/or
omitting material information concerning Paracelsus’s financial internal controls and reported earnings during the
Class Period.
Source: http://securities.stanford.edu/filings-case.html?id¼101241
Example Two
Defendant: Fairway Group Holdings Corp.
Filing Date: February 14, 2014
The Complaint alleges that throughout the Class Period, Defendants made materially false and misleading statements
regarding the Company’s business, operational and compliance policies. Specifically, Defendants made false and/or
misleading statements and/or failed to disclose that: (1) Fairway’s same store sales were declining; (2) the Company’s
direct store expenses were increasing; (3) the Company’s financial forecasts were wholly unrealistic; and (4) as a
result of the foregoing, Fairway’s public statements were materially false and misleading at all relevant times.
On February 6, 2014, Fairway reported earnings that severely missed analysts’ estimates including disappointing same
store sales, as well as increased direct store expenses. Moreover, the Company reported a substantial miss in EBIDTA
growth for the third quarter, as EBIDTA grew 3.2 percent over the same period in the prior year compared to growth
of 20–25 percent that management had forecast.
On this news, shares of Fairway fell $3.19 per share, more than 27.91%, on intraday trading, to a price of $8.24 on
February 7, 2014.
Source: http://securities.stanford.edu/filings-case.html?id¼105180

APPENDIX B
Variable Definitions
Variable Definition
Legal Changes
Nevada An indicator variable equal to 1 if a firm is incorporated in Nevada, and 0 otherwise. Source: Compustat.
Ninth An indicator variable equal to 1 if a firm is located in the states of the Ninth Circuit Court of Appeals,
including Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington.
Source: SEC Filings and Compustat.
Post1999 An indicator equal to 1 when the fiscal year is after 1999, and 0 otherwise.
Voluntary Disclosure Measures
Abs_CAR_8K The aggregated absolute value of the three-day cumulative abnormal returns to the voluntary 8-K filings
filed by a firm in a year; abnormal return is estimated using the market model. Source: SEC Filings and
CRSP.
Accuracy The average score of accuracy for all the annual and quarterly earnings forecasts made by a firm in a fiscal
year. We first calculate the absolute difference between a forecast and the actual earnings and then scale
the difference by the stock price at the end of the month prior to the forecast. Next, we sort the scaled
difference into quintiles and assign a score of 1 if it has the largest error (top quintile), 2 if in the second
quintile, 3 if in the third quintile, 4 if in the fourth quintile, 5 if in the bottom quintile, and 0 if no
forecasts are made. The value of 0 is excluded from a variant of the measure at the intensive margin.
Source: First Call Historical Database (FCHD)—Company Issued Guidance (CIG) and I/B/E/S
unadjusted detail files.
Disclosure An indicator variable equal to 1 if a firm makes annual or quarterly earnings forecasts in a fiscal year, and
0 otherwise. Source: FCHD—CIG.
Frequency The total number of annual and quarterly earnings forecasts made by a firm in a fiscal year. Source:
FCHD—CIG.
Horizon The average horizon of all the annual and quarterly earnings forecasts made by a firm in a fiscal year: for
each forecast, horizon is defined as the number of calendar days between the forecast announcement date
and the correspondingly forecast period end date; a value of 0 is assigned to a firm if no forecasts are
made in a year. The value of 0 is excluded from a variant of the measure at the intensive margin.
Source: FCHD—CIG.
Ln_Horizon The logarithm of 1 plus the average horizon of all the annual and quarterly earnings forecasts made by a
firm in a fiscal year. The value of 0 is excluded from a variant of the measure at the intensive margin.
Source: FCHD—CIG.
No_8K The number of voluntary 8-K forms filed by a firm in a year. We identify an 8-K filing as voluntary if it
contains items labeled as ‘‘Other Events.’’ Source: SEC Filings.
Precision The average score of precision for all the annual and quarterly earnings forecasts made by a firm in a fiscal
year: we assign a score of 0 if no estimates are made, 1 for qualitative estimates, 2 for open estimates, 3
for range estimates, and 4 for point estimates. The value of 0 is excluded from a variant of the measure
at the intensive margin. Source: FCHD–CIG.
Firm-Level Control Variables
Analyst Coverage The total number of unique analysts following a firm in a fiscal year. Source: I/B/E/S unadjusted detail
files.
Analyst Dispersion The standard deviation of analyst estimates for the current period’s earnings, scaled by the mean consensus
estimate. Source: I/B/E/S unadjusted detail files.
Institutional Ownership The average percent of shares owned by institutional investors of a firm in a fiscal year. Source: Thomson
Reuters Institutional Holding (13F) Database.
Leverage The ratio of total debt (Compustat variable DLTT þ DLC) over the market value of total assets
(Compustat variable AT CEQ þ CSHO PRCC_F) for each firm at each fiscal year-end. Source:
Compustat.
Log (Assets) The natural logarithm of total assets (Compustat variable AT) for each firm at each fiscal year-end. Source:
Compustat.
Loss An indicator variable equal to 1 if the operating income before depreciation (Compustat variable OIBDP) is
negative, and 0 otherwise. Source: Compustat.
(continued on next page)

APPENDIX B (continued)
Variable Definition
MTB The ratio of market equity to book equity, where market equity is calculated as the product of the closing
stock price (Compustat variable PRCC_F) and the number of common shares outstanding for each firm
at each fiscal year-end (Compustat variable CSHO), while book equity is measured by the value of
common or ordinary equity (Compustat variable CEQ). Source: Compustat.
ROA The operating income before depreciation (Compustat variable OIBDP) scaled by total assets (Compustat
variable AT) of a firm in a fiscal year. Source: Compustat.
Return Volatility The standard deviation of daily stock return (CRSP variable RET) of a firm over the last fiscal year.
Source: CRSP.
Regional Control Variables
GDP Growth Rate The growth rate of regional GDP in the current year relative to the previous year. For circuit-level GDP,
we sum up the state-level GDP over all the states in each circuit court. Source: BEA; see: https://www.
bea.gov/regional/downloadzip.cfm
Log (GDP per Capita) The natural logarithm of the ratio of current GDP over total population in the region. Source: BEA; see:
https://www.bea.gov/regional/downloadzip.cfm
Log (# of Public Firms) The natural logarithm of the number of public firms operating in a region. Source: Compustat.
This table summarizes the detailed definition and the source of the variables used in the analysis. The variables are categorized into four groups: Legal
Changes, Voluntary Disclosure Measures, Firm-Level Control Variables, and Regional Control Variables.
APPENDIX C
accr-52355_Online Appendix: http://dx.doi.org/10.2308/accr-52355.s01

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THE ACCOUNTING REVIEW American Accounting Association

Vol. 94, No. 5 DOI: 10.2308/accr-52355

Litigation Risk and Voluntary Disclosure: Evidence from

The Accounting Review

The Accounting Review

II. RELATED LITERATURE AND LEGAL BACKGROUND

Related Literature on Litigation Risk and Earnings Forecasts

The Accounting Review

The Accounting Review

III. SAMPLE, DATA, AND EMPIRICAL STRATEGY

Setting and Research Design

The Accounting Review

Data and Variables

The Accounting Review

IV. EMPIRICAL RESULTS

The Accounting Review

Panel A: Descriptive Statistics

Panel B: Balance Tests

The Accounting Review

Baseline Effect on Earnings Forecasts

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

Differential Effects on Positive and Negative News Forecasts

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

Volume 94, Number 5, 2019

Panel B: Issues with Control Group and Outcome Variables

The Accounting Review

Volume 94, Number 5, 2019

The Accounting Review

Additional Legal Events

The Accounting Review

Panel A: Supreme Court Decision on Tellabs in 2007

Panel B: Nevada Corporate Law Change in 2001

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

The Accounting Review

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