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Earnings Quality and Shareholders’ Class Action Lawsuits
Vic Naiker,
Auckland University
Farshid Navissi, Monash University
Keryn Chalmers, Monash University
ABSTRACT. One of the key recommendations of the Committee on Capital Markets Regulation issued in November 2006, is the need for greater clarity for private securities litigation under the SEC Rule 10-b5. The general conclusion from prior research is that when filing lawsuits the plaintiff shareholders are fixated solely on stock price declines and ignore other relevant factors such as firm performance (i.e., shareholders’ lawsuits filed under Rule 10b-5 are frivolous). Given the recent upsurge of debates on the need for more clarity in securities litigation our study contributes to this debate by examining the role of earnings quality in the incidence of shareholders’ class action lawsuits. The results from this examination indicate that unless stock price declines are preceded by significant deterioration of quality of financial statements, shareholders do not instigate legal actions against management. That is, shareholders’ lawsuits are on average meritorious.
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