ABSTRACT
We empirically test the predictions of costly reporting theory that the threat of shareholder litigation could induce financial reporting. We first find empirical evidence suggesting that litigation increases misreporting benefits as modeled in theory. We next show that consistent with theoretical predictions, litigation threat induces misreporting for firms with overly optimistic CEOs, for those with lower legal frictions, and for those with weaker internal controls. Last, we show that the lower litigation threat increases investment efficiency through its effect on misreporting. Our study provides the first empirical evidence supporting costly reporting theory that shareholder litigation affects not only the costs but also the benefits of misreporting.
Chen, Szu-fan and Tseng, Kevin, Does the Threat of Litigation Always Reduce Misreporting?. Posted to SSRN 13 June 2025.
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