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Accounting and Litigation Risk

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  • Zhiyan Cao
  • Ganapathi Narayanamoorthy
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    Abstract

    Litigation risk has been hypothesized to affect managerial behavior in a number of ways. An understanding of the determinants of litigation risk is a necessary first step to analyzing managerial behavior. We examine the determinants of an ex-ante measure of litigation risk, namely, Directors and Officers (D&O) liability insurance premium. We find that accounting risk is priced by D&O insurers. There is only limited evidence of traditional corporate governance measures getting priced. We also find some support that certain provisions of the Private Securities Litigation Reform Act, 1995 created specific litigation risk. Additionally, we present evidence that pricing for D&O premiums is lower for companies which adopted limited liability provisions to limit directors' exposure to litigation risk. Thus, adoption of these provisions can be a useful tool to reduce litigation risk. Finally, we find that the historical rise in insurance premium from 2001 to 2002 is associated with an increase in concerns about accounting quality.

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    File URL: http://icfpub.som.yale.edu/publications/2514
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    Bibliographic Info

    Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number amz2514.

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    Date of creation: 01 Nov 2005
    Date of revision: 01 Jul 2006
    Handle: RePEc:ysm:somwrk:amz2514

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    Web page: http://icf.som.yale.edu/
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    Related research

    Keywords: Litigation risk; accounting; D&O insurance;

    References

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    1. Paul A. Gompers & Joy L. Ishii & Andrew Metrick, 2002. "Corporate Governance and Equity Prices," Center for Financial Institutions Working Papers 02-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
    2. Nagar, Venky & Nanda, Dhananjay & Wysocki, Peter, 2003. "Discretionary disclosure and stock-based incentives," Journal of Accounting and Economics, Elsevier, vol. 34(1-3), pages 283-309, January.
    3. Skinner, Douglas J., 1997. "Earnings disclosures and stockholder lawsuits," Journal of Accounting and Economics, Elsevier, vol. 23(3), pages 249-282, November.
    4. DuCharme, Larry L. & Malatesta, Paul H. & Sefcik, Stephan E., 2004. "Earnings management, stock issues, and shareholder lawsuits," Journal of Financial Economics, Elsevier, vol. 71(1), pages 27-49, January.
    5. John M. R. Chalmers & Larry Y. Dann & Jarrad Harford, 2002. "Managerial Opportunism? Evidence from Directors' and Officers' Insurance Purchases," Journal of Finance, American Finance Association, vol. 57(2), pages 609-636, 04.
    6. Core, John E, 2000. "The Directors' and Officers' Insurance Premium: An Outside Assessment of the Quality of Corporate Governance," Journal of Law, Economics and Organization, Oxford University Press, vol. 16(2), pages 449-77, October.
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    Cited by:
    1. Zhiyan Cao & Ganapathi Narayanamoorthy, 2005. "The Effect of Litigation Risk on Management Earnings Forecasts," Yale School of Management Working Papers amz2379, Yale School of Management, revised 01 Feb 2009.

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