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This paper surveys the literature on the determinants and consequences of securities class action lawsuits against firms and auditors from a financial reporting quality perspective. The survey is motivated by the important role that law plays in protecting stakeholders’ interests against managerial misdeed. Litigation is, thus, an important topic and numerous studies investigate the determinants and consequences of firm and auditor lawsuits. The underlying premise of these studies is built on the notion that large financial and reputational penalties associated with successful securities class actions can discipline management and deter them from future wrongdoing. The survey documents that poor quality financial reporting as evidenced in earnings restatements has been the primary antecedent for class action lawsuits against the firm and auditors. Lawsuits against auditors affect audit fees, audit planning decisions and client portfolio adjustment decisions. Although significant progress has been made in terms of further understanding the causes and consequences of litigation against auditors, major challenges remain in the area of proper measurement of litigation risk.
6. Concluding remarks
This paper surveys a broad stream of literature on the determinants and consequences of securities class action lawsuits from the financial reporting and auditing perspectives. Although proponents of class action lawsuits provide convincing arguments that this legal mechanism allows investors to protect themselves from managerial misreporting, opponents find that the system encourages frivolous lawsuits. So much so, the Congress enacted PSLRA in 1995 to put a check on frivolous lawsuits. Academic research can provide useful insights into this ongoing debate and, consistent with this, a substantial volume of academic research exists on the causes and consequences of class action lawsuits against corporate managers, directors, and external auditors. Early literature was concerned about disclosures: in particular, bad news disclosures; in a timely manner. The evidence on this still remains inconclusive. One of the primary reasons for this inconclusive evidence on a fundamental question of this nature is the cause–effect relationship between variables. Although poor quality accounting information has been found to be incrementally useful in predicting lawsuits, it is not clear why managers should produce such reports in a very litigious environment. The challenge for researchers is to provide evidence on the association between disclosures and litigation after properly accounting for the endogenous relationship. A simultaneous equation system with litigation as both a dependent and an independent variable is promising.