Shareholder litigation and the information content of management voluntary disclosure

Abstract

In this paper I study the information content of managers’ voluntary disclosures in a shareholder litigation environment. I model the litigation mechanism in which the legal liability is based on the actual damages shareholders incur from buying a stock at an inflated price. I find that the optimal disclosure strategy in equilibrium does not fully reveal a manager’s information and has the manager making what are essentially range disclosures. In addition, more favorable news is more informative than less favorable news when legal liability is high, and the converse is true when legal liability is low. I also find that increasing the severity of legal liability does not necessarily induce more precise disclosures. Initially, the disclosure precision is enhanced by increases in legal liability, but beyond a point, increases in legal liability reduce the disclosure precision.