The Relation Between Earnings Changes and Discretionary Disclosure in Periods of Bad Economic Performance

John J. Shon
University of Chicago

Abstract: I investigate the relation between earnings changes and discretionary disclosure behavior in an environment of heightened litigation risk. Because Rule 10b-5 lawsuits are rarely filed for firms with good equity returns, I select a sample of firms that experience negative equity returns—but not necessarily negative earnings performance. Inconsistent with the litigation hypothesis, I find that negative earnings-change firms make fewer preemptive earnings disclosures. However, such firms provide more negative information content in non-earnings-related disclosures. Conversely, though prima facie positive earnings-change firms disclose similarly (in number and timeliness), they remain relatively silent with respect to the negative information content of the disclosures made. Results highlight the non-trivial difference that sample selection can have on inferences regarding disclosure behavior. Overall, in high-litigation environments, earnings and discretionary disclosures serve complementary roles, suggesting that firms may not supplement “uninformative” earnings with informative discretionary disclosures—even when faced with high expected litigation costs.

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