The scale and scope of corporate litigation exposure and the factors that explain contingent loss disclosures

Abstract

We collect a sample of 75,421 lawsuits filed against 90,255 public company defendants from 2006 through 2016 using federal district court docket information. These lawsuits involve an array of allegations, including product liability, civil rights discrimination, improper compensation and labor practices, antitrust violations, pollution, trademark and copyright violations, and patent infringement. The vast majority of these lawsuits likely do not make it onto the radar of investors: only 3% of lawsuit-defendants disclose the pending litigation at any point, with disclosure by plaintiffs and fellow defendants increasing the overall rate of disclosure to 6%. If disclosed, the decision to do so typically occurs early in the legal process, suggesting that the type of claim and the circumstances surrounding its filing—as opposed to how the lawsuit unfolds over time—drive the decision to disclose. Prior SEC scrutiny, the desire to hide potential losses that may make existing debt look particularly risky, and incentives to shape the narrative relative to other available lawsuit information factor into firms’ disclosure decisions. We also find that increased contingency-related concerns expressed in SEC comment letters coincided with the FASB’s consideration of loss contingencies in the 2008 to 2012 timeframe. Yet, the rate of disclosure (particularly of losses) declined over our sample period. Overall, our findings inform the debate about contingency disclosure standards and enforcement. In so doing, our study offers researchers a measure of overarching legal exposure that allows for the study of litigation risk, as well as firm risk more broadly, from new and increasingly relevant perspectives.