Shareholder Litigation Risk and Managers’ Private Disclosure of Earnings Warnings

Abstract

This paper examines managers' use of a private disclosure channel to provide early earnings warnings and therefore reduce bad news shocks around public announcements. I ask whether firms are more likely to provide private earnings warnings to analysts when expected shareholder litigation risk increases. To identify private communication, I measure variation in firms' propensity to privately disclose earnings warnings using the difference between analysts' and a selected group of benchmark forecasters' revisions of short-term earnings forecasts around earnings announcements. Using plausibly exogenous variation in expected shareholder litigation risk based on judge ideology, I find that managers are more likely to leak bad news privately when shareholder litigation risk increases. This effect is concentrated among large firms that are more likely the target of shareholder lawsuits. I conclude that firms react to the legal system by disclosing private earnings warnings to ensure stock prices incorporate this information in a timely manner.