Knowledge that Transforms

Securities litigation poses large costs to firms. The risk of litigation is heightened when firms have unexpectedly large earnings disappointments. Previous literature presents mixed evidence on whether voluntary disclosure of the bad news prior to scheduled earnings announcements deters or triggers litigation. We show that the counterintuitive finding in prior literature that disclosure triggers litigation could be driven by the endogeneity between disclosure and litigation. Using a simultaneous equations methodology, we find no evidence that disclosure triggers litigation. In fact, consistent with economic arguments, our evidence suggests that disclosure potentially deters certain types of litigation.

Executives are ‘affiliated’ if they previously worked for their companies’ audit firms. I find most affiliations (71.3%) occur when auditors become employees of audit clients (‘employment affiliations’), but affiliations also arise when companies hire executives’ former CPA firms (‘alma mater affiliations’). Affiliated companies are significantly more likely than unaffiliated companies to receive clean audit opinions—this finding holds for both employment and alma mater affiliations. Executive turnover is significantly lower for affiliated executives than for unaffiliated executives following the issuance of clean audit opinions—this suggests companies perceive affiliations are more valuable after they receive clean audit opinions.

Analysts with above-median risk-adjusted performance in the estimation period persistently outperform those with below-median performance in the subsequent holdout period. The annualized risk-adjusted returns of trading strategies based on performance persistence are statistically and economically significant, with a magnitude around 10% even after adjusting for transaction costs and trading delays. This stems mostly from past above-median performers and is not simply a decomposition of previously documented post-event return drift. The results support the hypotheses that more information is contained in above-median performers’ recommendations and that investor reaction to these recommendations is incomplete during the event periods.

I examine how revenue recognition timing affects attributes of reported revenue, using a sample of software firms that adopted Statement of Position 91-1 in the early 1990s. I find early recognition yields more timely revenue information, as evidenced by higher contemporaneous correlation with information impounded in stock returns. However, such early recognition diminishes the extent to which accounts receivable accruals map into future cash flow realizations and lowers the time-series predictability of reported revenue. Overall, the results suggest early revenue recognition makes reported revenue more timely and more relevant, but at the cost of lower reliability and lower time-series predictability.