How Does the Legal Environment Shape Qualitative Disclosure? Evidence from a Landmark Court Ruling

How the legal environment shapes firms’ disclosure practices is a longstanding question in accounting research. However, the definition of “disclosure” in prior research is frequently limited to the frequency of management forecasts, and much of the existing research on this topic is subject to endogeneity concerns. Motivated by the upward trend of shareholder lawsuits filed over qualitative disclosure, I investigate how litigation risk affects the amount of qualitative disclosure, the trade-off between qualitative and quantitative information, and the quality of qualitative disclosure in 10-K reports using a landmark court ruling as an exogenous shock to the litigation risk of firms headquartered in the Ninth Circuit. Adopting an entropy balanced difference-in-differences design, I find that treated firms provide less qualitative information but more quantitative information through 10-Ks following the decrease in litigation risk, suggesting that firms use qualitative disclosure and quantitative disclosure as substitutes. Further, the quality of qualitative disclosure seems to improve. Treated firms engage in less tone management and write more readable 10-Ks after litigation risk decreases. Additional evidence suggests that analyst forecast accuracy improves following the decline in litigation risk.