Do Managers Respond to Litigation with Silence?

Abstract

Prior work concludes that managers respond to litigation with reduced disclosure. In this study, we document that the nature of disclosure matters. Although we confirm a drop in the overall level of disclosure following litigation, we find that while forecasts of positive news fall, bad news warnings actually increase. Moreover, while good news arrives later, bad news arrives earlier in the post-lawsuit period. Our evidence also indicates that managers who warned previously (including those whose warnings appeared to trigger the lawsuit-provoking price drop) do not emerge from litigation skeptical of the effectiveness of warning. On the contrary, we find that in the post-lawsuit period, prior warners warn earlier and more frequently. Further, consistent with the notion that litigation motivates managers to reevaluate the costs of trading to exploit earnings news, we document a reduction in post-lawsuit selling that is driven by a drop in opportunistic (as opposed to routine) trades that concentrate in the two-week, open trading window following quarterly earnings releases. Collectively, our findings suggest that managers respond to litigation by emphasizing early, cautionary warnings while also reducing and delaying their good news disclosures and limiting their opportunistic trading. Thus, this study provides an important alternative viewpoint of the potential effects of litigation on managers' decision to provide guidance and firms' information environments.