Regulation G requires all companies to quantitatively reconcile pro forma earnings with GAAP earnings. This paper provides three findings related to the impact of reconciliations on mispricing of pro forma earnings. First, prior to Reg G, we find that mispricing of pro forma earnings is limited to firms with low reconciliation quality. There is no evidence of mispricing for firms with high reconciliation quality. Second, we find no evidence of mispricing after Reg G. Third, there is a cross-Reg G reduction of mispricing for firms whose reconciliation quality improves, and there continues to be no mispricing for firms that have high reconciliation quality both before and after Reg G. Together, our results support the notion that better reconciliations reduce the extent of mispricing.

Securities litigation risk is a well‐recognized yet underexplored source of financial reporting complexity or unreadability. This study examines the effect of litigation risk on the readability of corporate financial reports. The 1999 Silicon Graphics Inc. (SGI) court ruling unexpectedly reduced litigation risk for firms within the Ninth Circuit Court's jurisdiction. Using a difference‐in‐differences design centered on the SGI court ruling, we find that, while the readability of financial reports generally declines over the sample period, treated firms in the Ninth Circuit experience a comparatively smaller decline in readability than control firms in other states after the ruling. Put differently, treated firms experience a relative improvement in reporting readability following the ruling. This effect is concentrated among firms prone to securities litigation and those with greater external financing needs, but it is muted for firms engaging in earnings management. Furthermore, improved reporting readability among treated firms can be partially attributed to alleviated concerns about the adequacy of cautionary language, as evidenced by a significant decrease in negative forward‐looking statements, particularly risk‐related ones. Collectively, our findings suggest that securities litigation risk contributes to reduced readability in financial reporting.

Despite a longstanding debate over the pros and cons of imposing legal liability on directors and officers (D&Os), there is limited evidence on how D&O liability affects corporate innovation. We study this question by exploiting Nevada's 2001 corporate law change that dramatically lowered D&O legal liability and helped Nevada become the second most popular state for out-of-state incorporations. We find that firms incorporated in Nevada exhibit an increase in innovation outputs relative to matched control firms after the law change, particularly firms facing higher litigation risk or operating in more innovative industries. The results are driven mainly by exchange-listed firms that are subject to better governance than over-the-counter (OTC) listed firms. Lower D&O liability also enables firms to pursue more risky, but potentially more rewarding, explorative innovation. Therefore, although holding D&Os liable may be desirable overall, it also entails a cost by discouraging innovation in some firms. Our study has implications for how the litigation environment may influence sustainable growth via innovation.

This study examines the impact of political corruption on the provision of CEO risk-taking incentives. We hypothesize that firms adjust their CEO’s risk-taking incentives to reflect the influence of local political corruption on the firms’ desired level of risk-taking. Using U.S. Department of Justice data on local political corruption, we find that the sensitivity of CEO wealth to stock volatility (vega) is lower in firms located in high-corruption districts. The negative impact of corruption on vega is more pronounced among (1) firms operating in industries that are more dependent on government procurement, (2) firms operating in more innovative industries, and (3) firms without political connections. Our study offers new insights into how the institutional environment shapes executive compensation design. Data Availability: Data are available from the public sources cited in the text.

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