Abstract
In this paper, we establish a causal relation between litigation risk and management earnings forecasts, exploiting the exogenous reduction in litigation threat generated by the 1999 ruling of the Ninth Circuit Court of Appeals. Following the ruling, we find that the treated firms in the Ninth Circuit states, tend to make fewer management earnings forecasts, and are particularly reluctant to convey negative news. They also deliver forecasts in a less timely fashion and with lower precision and accuracy. Taken together, these results are consistent with the “litigation deterrence” motive of making earnings forecasts. Finally, we investigate the interaction of the litigation environment and firms’ capital market needs in jointly shaping earnings forecast practices. We find that the reduction of negative news forecasts is more pronounced for firms with large financial constraints and/or a greater need for external funds.
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