Resolution of restatement-induced lawsuits after the Private Securities Litigation Reform Act

Using a sample of 185 restating firms that were sued between 1997 and 2005, we examine the role of accounting irregularity, other restatement characteristics and the Sarbanes Oxley Act in the resolution of litigation after the Private Securities Litigation Reform Act (PSLRA). The empirical results indicate that restatement due to an accounting irregularity and investigation of accounting misstatement by the Securities and Exchange Commission (SEC) are associated with a higher probability of settlement. Furthermore, the more negative the investor reaction to a restatement, the higher the probability that a lawsuit will be settled. Finally, we do not find any evidence that the Sarbanes Oxley Act is associated with the probability of a settled lawsuit. Our findings suggest that restatement-induced lawsuits with strong inference of fraud are settled in the period after the PSLRA. The results also highlight the importance of making a distinction between dismissed and settled restatement-induced lawsuits.     

Material weakness disclosures and restatement announcements: The joint and order effects

We examine differences in stock price, option volatility, and litigation reactions to restatement announcements that are associated with a material weakness (MW) disclosure. Contrasted with restatements that are not associated with any MW disclosure, our analyses reveal that firms that announce both a restatement and an associated MW experience significantly more negative market returns, greater implied volatility, and higher likelihood of class action lawsuits. Separating the restatements into timely reporters, where the MW precedes the restatement, and non‐timely reporters, where the MW is concurrent with or follows the restatement, we find that timely reporters experience more negative returns at the time of the restatement, relative to non‐timely reporters, suggesting that investors perceive the early MW disclosure to signal more pervasive control‐related problems. Interestingly, we find that timely and non‐timely reporters are equally likely to be sued, consistent with the argument that wrongdoing (through either a timely or non‐timely MW disclosure) provides stronger grounds for establishing scienter. However, timely reporters appear to secure more favorable litigation outcomes: they face higher likelihood of lawsuit dismissals and pay much lower settlements, compared to non‐timely reporters. Overall, our evidence provides new insights into how market participants incorporate information about internal control weaknesses into their perceptions regarding the economic implications of financial restatements, and financial reporting quality.     

Institutional monitoring through shareholder litigation

This paper investigates the effectiveness of using securities class action lawsuits in monitoring defendant firms by institutional lead plaintiffs from two aspects: (1) immediate litigation outcomes, including the probability of surviving the motion to dismiss and the settlement amount, and (2) subsequent governance improvement such as changes in board independence. Using a large sample of securities lawsuits from 1996 to 2005, we show that institutional investors are more likely to serve as the lead plaintiff for lawsuits with certain characteristics. After controlling for these determinants of having an institutional lead plaintiff, we show that securities class actions with institutional owners as lead plaintiffs are less likely to be dismissed and have larger monetary settlements than securities class actions with individual lead plaintiffs. This effect exists for various types of institutions including public pension funds. We also find that, after the lawsuit filings, defendant firms with institutional lead plaintiffs experience greater improvement in their board independence than defendant firms with individual lead plaintiffs. Our study suggests that securities litigation is an effective disciplining tool for institutional owners.     

Executive compensation,earnings management and shareholder litigation

This paper examines the effects of executive compensation and potential for earnings management on the incidence of shareholder class action lawsuits and their outcomes. Although damage measurement factors, managerial option intensity, and earnings management all significantly affect the probability of lawsuits, they differ in their influence on the likelihood of positive settlement and on settlement amount: Damage factors do not affect the likelihood of settlement versus dismissal. High option intensity raises the probability of positive settlement, but does not affect its amount. High earnings management, on the other hand, does not affect the likelihood of settlement, but does increase settlement amount. These findings suggest that factors typically used to explain shareholder lawsuits should be interpreted with care.     

Rewriting earnings history

Research on the usefulness of financial information generally focuses on the innovation in the information examined, such as an earnings surprise or cash flow growth. Consequently, prior research sheds little light on the role of the rich historical record of financial information in users’ decision-making. Using a sample of published restatements of earnings, we show that the revision of the historical pattern of earnings, distinct from the magnitude of the restatement and its impact on current earnings, significantly affects investors’ decisions and predicts class action lawsuits. Specifically, we find that restatements that eliminate or shorten histories of earnings growth or positive earnings have significantly more adverse effects for investor valuations and the likelihood of lawsuits than other restatements. This evidence about the value-relevance of refreshing the historical record of earnings is pertinent to the FASB’s recent cautious expansion of the scope of circumstances that require a restatement of financial information in FAS 154.

Consequences of Financial Reporting Failure for Outside Directors: Evidence from Accounting Restatements and Audit Committee Members

I use a sample of 409 companies that restated their earnings from 1997 to 2001 to examine penalties for outside directors, particularly audit committee members, when their companies experience accounting restatements. Penalties from lawsuits and Securities and Exchange Commission (SEC) actions are limited. However, directors experience significant labor market penalties. In the three years after the restatement, director turnover is 48% for firms that restate earnings downward, 33% for a performance‐matched sample, 28% for firms that restate upward, and only 18% for technical restatement firms. For firms that overstate earnings, the likelihood of director departure increases in restatement severity, particularly for audit committee directors. In addition, directors of these firms are no longer present in 25% of their positions on other boards. This loss is greater for audit committee members and for more severe restatements. A matched‐sample analysis confirms this result. Overall, the evidence is consistent with outside directors, especially audit committee members, bearing reputational costs for financial reporting failure.     

Stock Price Response to News of Securities Fraud Litigation: An Analysis of Sequential and Conditional Information

This study examines investor response to three events that help define a federal class action securities lawsuit, specifically, the announcement that names an issuer as a defendant in the lawsuit (at the class action filing date), the disclosure or accounting restatement that 'corrects' the information deficiency (at the end of the class period), and the date at which the fraud on the market allegedly begins (at the beginning of the class period). We document a significant and predictable stock price response at each of these three events. Our tests also indicate that the market interprets these events not in isolation but as sequential and conditional events. Investor response differs on the basis of the characteristics of the issuer, the allegations in the complaint, and the outcome of the litigation. These results and the fact that we observe no systematic price momentum in investor response beyond the announcement dates imply that the market is reasonably efficient with respect to information about securities fraud litigation. Our results are robust to alternative definitions and procedures, and are based on a proprietary database that includes almost all federal securities class action lawsuits since 1990.     

Accountability of independent directors: Evidence from firms subject to securities litigation

We examine which independent directors are held accountable when investors sue firms for financial and disclosure-related fraud. Investors can name independent directors as defendants in lawsuits, and they can vote against their reelection to express displeasure over the directors’ ineffectiveness at monitoring managers. In a sample of securities class action lawsuits from 1996 to 2010, about 11% of independent directors are named as defendants. The likelihood of being named is greater for audit committee members and directors who sell stock during the class period. Named directors receive more negative recommendations from Institutional Shareholder Services, a proxy advisory firm, and significantly more negative votes from shareholders than directors in a benchmark sample. They are also more likely than other independent directors to leave sued firms. Overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.     

Financial fraud,director reputation,and shareholder wealth

We investigate the reputational impact of financial fraud for outside directors based on a sample of firms facing shareholder class action lawsuits. Following a financial fraud lawsuit, outside directors do not face abnormal turnover on the board of the sued firm but experience a significant decline in other board seats held. This decline in other directorships is greater for more severe allegations of fraud and when the outside director bears greater responsibility for monitoring fraud. Interlocked firms that share directors with the sued firm also exhibit valuation declines at the lawsuit filing. Fraud-affiliated directors are more likely to lose directorships at firms with stronger corporate governance and their departure is associated with valuation increases for these firms.     

Corporate social responsibility and litigation risk: Evidence from securities class action lawsuits

This study examines whether corporate social responsibility (CSR) is associated with the likelihood and outcomes of securities class action lawsuits. We find a lower likelihood of securities litigation for firms with higher CSR. This effect is larger for companies with lower levels of financial distress, companies with larger proportions of institutional investors, and for internal CSR. Additionally, CSR has a mitigating effect on negative market assessments around the filing dates of securities litigation. The results suggest that higher CSR firms are less likely to engage in financial misconduct, and investors are less likely to penalise them for such occurrences.     

Shareholder litigation in mergers and acquisitions

Using hand-collected data, we examine the targeting of shareholder class action lawsuits in merger and acquisition (M&A) transactions, and the associations of these lawsuits with offer completion rates and takeover premia. We find that M&A offers subject to shareholder lawsuits are completed at a significantly lower rate than offers not subject to litigation, after controlling for selection bias, different judicial standards, major offer characteristics, M&A financial and legal advisor reputations as well as industry and year fixed effects. M&A offers subject to shareholder lawsuits have significantly higher takeover premia in completed deals, after controlling for the same factors. Economically, the expected rise in takeover premia more than offsets the fall in the probability of deal completion, resulting in a positive expected gain to target shareholders. However, in general, target stock price reactions to bid announcements do not appear to fully anticipate the positive expected gain from potential litigation. We find that during a merger wave characterized by friendly single-bidder offers, shareholder litigation substitutes for the presence of a rival bidder by policing low-ball bids and forcing offer price improvement by the bidder.     

The causes and consequences of securities class action litigation

We examine the impact of securities class action lawsuits on firms' investment and financing choices. Firms which overinvest are more likely to be sued. After a lawsuit, firms on average decrease overinvestment activity, and they decrease payouts while increasing leverage, cash holdings, and firm-specific risk. Additionally, we find some evidence that firms decrease diversification post-suit. Overall, these changes are consistent with a post-suit decrease in agency problems which lead to significant changes in real investment policies. The evidence is consistent with the notion that security class action lawsuits draw attention to agency problems which are then at least partly resolved.     

Corporate misreporting and bank loan contracting

This paper is the first to study the effect of financial restatement on bank loan contracting. Compared with loans initiated before restatement, loans initiated after restatement have significantly higher spreads, shorter maturities, higher likelihood of being secured, and more covenant restrictions. The increase in loan spread is significantly larger for fraudulent restating firms than other restating firms. We also find that after restatement, the number of lenders per loan declines and firms pay higher upfront and annual fees. These results are consistent with banks using tighter loan contract terms to overcome risk and information problems arising from financial restatements.     

Class action lawsuits and executive stock option exercise

In a large sample of shareholder initiated class action lawsuits from 1996 to 2011, we find a significant increase in informed insider option exercises during the class action period compared to the preceding quarter, and we find that this change is positively related to the probability of litigation. The market reaction to the announcement of lawsuits is negatively related to abnormal informed option exercises, but positively related to suits that ultimately get dismissed. These results suggest that the market can at least partially anticipate the merits and severity of the class action suit. In subsequent analyses, we find that CEO turnover is positively related to litigation, but not option exercises. Collectively, our results indicate that insiders knowingly trade on their private information.     

The Effects of Executive,Firm, and Board Characteristics on Executive Exit

We estimate a hazard model of the probability of top corporate executives exiting their firms over the period 1996–2010. Our main findings are that: (1) female executives have greater likelihoods of exit than males, (2) the likelihood of exit increases with the independence of the board and decreases with the fraction of the board that is female and the average age of board members, and (3) a higher percentage of independent directors on the board lowers the probability of exit more for females than for males. Further, controlling for exit risk reduces the well‐documented compensation differential between men and women.     

Effective board monitoring over earnings reports and forecasts: Evidence from CFO outside director appointments

Prior evidence that firms adjust their board structure following accounting restatements suggests that firms expect the board to effectively monitor the firm’s financial accounting system. However, little is known about signals firms use to identify monitoring weaknesses or the types of individuals firms appoint to improve the quality of monitoring. We expand on Ghannam, Bujega, Matolcsy, and Spiropolous (2019)’s evidence that firms appoint directors with accounting experience after financial fraud by investigating whether firms that file restatements or issue highly inaccurate earnings forecasts appoint individuals with CFO experience (i.e., a subset of accounting experts) to their audit committee. We find that firms are more likely to appoint an outside director with CFO experience to the audit committee when they have recently restated earnings and when they have higher prior management forecast error. We also find that the appointment of a CFO outside director to the audit committee is followed by a lower likelihood of restatement and more accurate management forecast. Together, our results suggest that firms respond to accounting failures by appointing outside directors with CFO experience. Thus, we provide insight into the signals firms use to identify weaknesses in the monitoring of the accounting function and the types of expertise firms value in addressing those weaknesses.     

The effect of securities class action lawsuits on mergers and acquisitions

This paper investigates whether shareholder class action litigation affects the takeover candidacy, premium, and completion rate of mergers and acquisitions involving defendant target firms. We use a comprehensive dataset of publicly traded U.S. firms that became the targets of takeover bids between 1998 and 2016 and find that firms subject to shareholder class action lawsuits within the previous two years are more likely to be targeted for acquisition while commanding a significantly higher premium. Firms that face such litigation after a takeover announcement experience a significant decrease in takeover completion.     

Third-party auditor liability and financial restatements

We examine whether U.S. state-level third-party auditor liability (TPAL) regimes affect firms' financial restatement decisions. Using a sample of 34,409 firm-year observations from 2003 to 2018, we find that state-level TPAL is significantly negatively related to the likelihood of firm-level financial restatements. We also observe that the negative relationship between TPAL and financial restatements persists for a subsample of firms with income-increasing financial restatements and the ‘restatement of torts standard’ (one of the more expansive subgroups of TPAL). Using a difference-in-differences regression design, we find that an increase in state-level TPAL regimes strengthens the negative relationship between TPAL and the incidence of restatements. Our main finding remains robust across several sensitivity tests. Finally, we find that the negative relationship between TPAL and restatements is more pronounced when firms are subject to greater litigation risk and when firms are audited by non-specialist auditors. Overall, we show that TPAL has important implications for client firms' financial restatements.     

责任保险第三人直接诉讼法律适用国际比较研究——从法律选择方法的价值目标及其实现路径的维度

分析比较直接诉讼法律适用的欧美方法,指出其共同的价值目标是追求实体法正义,但实现实体法正义的路径各不相同。结合我国的现实背景,指出我国应采用反映支持直接诉讼的实体法政策目标的法律选择方法处理涉外直接诉讼案件,建议修改《涉外民事关系法律适用法》,参照欧洲做法规定有关直接诉讼的结果导向冲突规则,或参照美国做法就最密切联系原...     

Earnings quality and Rule 10b-5 securities class action lawsuits

This study examines the earnings quality of firms sued under accounting-related Rule 10b-5 securities fraud class action lawsuits, following a decline in their stock prices, relative to earnings quality of a return-matched control sample of firms. Our analysis is conducted in pre- and post-Private Securities Litigation Rule Act (PSLRA) periods. We measure accruals (earnings) quality using the Dechow and Dichev (2002) model, and provide evidence of significantly lower quality earnings (earnings overstatement) in both the pre- and post-PSLRA periods, for the test sample firms in the four quarters immediately prior to the sued quarter, followed by a sharp decline in the level of earnings of the sued quarter and subsequent four quarters. These consistent results in the pre- and post-PSLRA suggest that lower earnings quality is merit-related indicia of evidence of fraud and that accounting based securities class action lawsuits target only firms with lower earnings quality. Our findings suggest that further policy reforms making it more difficult for shareholders to file an accounting based securities class action lawsuit would be unwarranted.