Publication on Legal Risks and Reporting

How Court Rulings Impact Businesses: Insights by our Professor Benedikt Franke, Allen Huang (HKUST), Reeyarn Li (University of Paderborn), and Hui Wang (Renmin Univeristy of China)

Understanding how the legal system affects businesses involves not just written but also how courts interpret them. Our recent study analyzes 321 circuit court ruling decisions in the United States to shed light on this crucial aspect.

What We Did: A New Approach

We developed a novel measure to gauge how courts view defendants in securities lawsuits. This helped us uncover insights into how legal precedents set by the courts influence firms' litigation risks.

Key Discovery: Reducing Lawsuit Risks

We found a clear link: Companies involved in financial misreporting face fewer lawsuits in jurisdictions where courts are more lenient towards defendants. This tends to lower the expected costs associated with legal battles.

Effects on Markets and Reporting

In these defendant-friendly circuits, companies face less negative market reactions when misreporting is exposed, suggesting the investors expect fewer or less severe repercussions. This results in companies reducing their spending on preventing misreporting and having a tendency to engage in riskier reporting practices.

Takeaway: Legal Precedents Matters

Our research underscores the importance of legal precedents. As defendant-friendly decisions can reduce acompany's legal risk, they may also compromise the quality of financial reporting. As political polarization among legislators impedes the passage of new laws, the importance of judicial interpretations of existing statutes may grow even further.

The paper is published by the Review of Finance.

#LegalInsights #BusinessImpact #LitigationRisk