The role of accounting quality in securities class action lawsuits.

Abstract

Prior evidence suggests that stock price declines are the main driver for filing securities class action lawsuits and that case merit plays a minor role in both the decision to file a case and the case outcome. I use accounting quality as a proxy for managerial wrongdoing and test whether accounting evidence determines lawsuit filing decisions and distinguishes frivolous cases from those with merit. My results show that accruals quality, measured by accrual reliability, discretionary accruals, and reporting opacity in relation to intangible assets, significantly impact the decision to file a lawsuit. I also find that lower accounting quality in the form of accrual reliability, discretionary accruals, and reporting opacity in the form of R&D impact the magnitude of settlement amounts. These ex ante measures of accounting quality serve as leading indicators of case outcomes even after controlling for return performance and hard evidence events such as accounting restatements and SEC investigations. Overall, my findings suggest that accounting data is used by the legal system as a determinant of lawsuit filings and outcomes.