The effect of firm-specific litigation risk on independent director conservatism

Abstract

Purpose

The purpose of this study is to examine whether firm-specific litigation risk affects independent director conservatism in the oversight of financial reporting.

Design/methodology/approach

This study considers the enactment of Sarbanes–Oxley Act and the main US stock exchanges' corresponding corporate governance regulations in 2002–2003 as an exogenous shock event to increase board independence. OLS regressions with fixed effects are conducted to test the hypothesis.

Findings

Changes in discretionary accruals from the pre-event year (2001) to the post-event year (2004) are more negatively associated with an exogenous increase in board independence for firms with high litigation risk than for firms with low litigation risk.

Originality/value

The results suggest that independent directors are more conservative in overseeing financial reporting when they face higher litigation risk, consistent with the notion that they are still concerned about liability risk although they seldom have to pay damages or legal fees out of their own pockets.

Citation

Liu, G. and Sun, J. (2022), "The effect of firm-specific litigation risk on independent director conservatism", Managerial Finance, Vol. 48 No. 1, pp. 96-112. https://doi.org/10.1108/MF-08-2020-0442