Accounting choices and the legal environment: The impact of the ex post loss rule

• Main Author: TAN, Teck Meng Junior
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2018
• Subjects: Write-downs; Accruals; Supreme Court; Securities Litigation; Accounting; Accounting Law
• Online Access: https://ink.library.smu.edu.sg/soa_research/1723; https://ink.library.smu.edu.sg/context/soa_research/article/2750/viewcontent/SSRN_id2857703.pdf
• Institution: Singapore Management University

Using a landmark Supreme Court decision as a natural experiment, I examine the impact of a fundamental requirement in securities litigation, the ex post loss rule, on income-decreasing accounting choices. Dura Pharmaceuticals v. Broudo (2005) established that plaintiffs must show that the alleged misrepresentations caused an actual economic loss. The case resolved a circuit split, allowing me to identify a treatment jurisdiction affected by Dura, and control jurisdictions in which the rule was already the prevailing legal standard. Motivated by legal analyses suggesting that Dura incentivizes firms to delay negative corrections, I hypothesize and find that treatment firms in high-litigation industries became more likely to delay write-downs and income-decreasing accrual error reversals at the firm level after Dura, relative to matched control firms. This paper sheds light on the relationship between securities law and accounting practices, and informs policy makers on the accounting impact of a key feature of the legal environment.