Does Litigation Risk Affect Meeting-or-Beating Earnings Expectations? Evidence from Quasi-Natural Experiment

This paper examines the impact of litigation risk on meeting-or-beating earnings expectations (MBE). Whether and how litigation risk affects MBE is largely inconclusive due to potential reverse causality and measurement error. To find a causal effect, this study employs differences-in-differences tests based on the unanticipated legal event that decreased litigation risk for firms headquartered in the U.S. Ninth Circuit states. The result indicates that Ninth Circuit firms are more likely to meet or beat their earnings target after the ruling, suggesting that litigation risk negatively affects the likelihood of MBE. Further analyses show that investors’ reactions are less positive to MBE premium for firms with a decrease in litigation risk. Taken together, this study contributes to the literature by documenting that litigation risk is a significant factor influencing managers’ benchmark beating behavior.