Title: Disclosure Tone and Shareholder Litigation (Subscription or fee required.)
Author: Jonathan L. Rogers (University of Chicago), Andrew Van Buskirk (Ohio State University), and Sarah L.C. Zechman (University of Chicago)
Publisher: The Accounting Review, vol. 86, no. 6
Date Published: November 2011
Firms that issue overly optimistic disclosures face an increased likelihood of being sued by shareholders, this paper finds. Although managers often see a need to paint their firms in a more positive light, this study warns that too much unfounded hype can lead to a courtroom showdown — and that officers and directors of companies should work hard to ensure that their firms’ communication remains grounded in reality.
The researchers decided to study the tone of corporate disclosures — in particular, optimism — because plaintiff allegations in typical disclosure-related securities lawsuits tend to center on the same premise: Investors allege that their expectations about a company’s value were improperly raised by upbeat messages from the firm. These disclosures can take the form of press releases, earnings announcements, media interviews, presentations at conferences, and SEC filings.
The researchers obtained litigation data from Woodruff-Sawyer & Company, a San Francisco–based insurance brokerage firm. For a lawsuit to be included in the study, it had to have been filed in federal court against a corporation, alleging fraud involving the defendant’s stock price, and including charges of material misrepresentations or omissions regarding the true value and potential of the firm.
Because the researchers were focusing on the relationship between discretionary disclosures and litigation risk, they did not include lawsuits concerning mergers and acquisitions, earnings restatements, and initial public offerings. The final sample consisted of 165 lawsuits filed between 2003 and 2008, and the periods of managers’ alleged misconduct ranged from one month to five years. Slightly more than half of the lawsuits involved five industries: chemicals and allied products, electronics, business services, insurance carriers, and financial analysis. The researchers augmented the survey data with information from several corporate and legal databases, including Compustat and the Center for Research in Security Prices.
They began their analysis by looking at plaintiff complaints in a random selection of 20 of the 165 lawsuits in the sample. Their initial goal was to determine which type of communication was cited most consistently, reasoning that statements in this form of communication were the ones most likely to expose a firm to the risk of litigation.
Out of almost 300 unique communications cited in this subset of lawsuits, earnings announcements popped up the most, appearing in 18 of the 20 lawsuits. In the full sample, more than half of the damage periods cited in the suits — the damage period is the window of time during which a firm is accused of improper conduct — began on the date of an earnings announcement, suggesting that a press release or conference call tied to the announcement contained the first alleged misrepresentation. Accordingly, the authors focused on earnings announcement disclosures.
Next, the researchers explored whether plaintiffs targeted firms’ positive statements, based on an analysis of the wording that was cited in the complaints. Using three dictionary-based text analysis programs, all of which have been employed in previous studies to parse corporate language, the researchers separately considered the tone of the quoted statements and the tone of the rest of the earnings announcements.
In 91 percent of the earnings announcements that were analyzed, the portion quoted by plaintiffs was much more optimistic than the non-quoted portion. “To our knowledge,” the authors write, “this is the first concrete evidence for the intuition that plaintiffs target optimistic language when bringing actions against [a] firm.”