Strategic Silence, Insider Selling and Litigation Risk

Abstract

Prior work finds that managers beneficially time their purchases, but not sales, prior to forecasts. Focusing on if (as opposed to when) a forecast is given, we link insider selling to silence in advance of earnings disappointments. This raises the question of whether the absence of incriminating trading drives reductions in litigation risk potentially attributed to warnings. We find that the absence of a warning combined with the presence of selling exacerbates the consequences associated with the individual behaviors. Yet, selling prior to a warning typically does not offset all of the warning‫׳‬s benefit. In so doing, we supply the first robust evidence of a litigation benefit associated with warning. December 2014Journal of Accounting and Economics, forthcoming AbstractPrior work finds that managers beneficially time their purchases, but not their sales, prior to their forecasts. Shifting attention from when forecasts are given to if a forecast is given, we link insider selling to silence in advance of an earnings disappointment. In particular, our evidence indicates that managers who deliver disappointing news next quarter are less likely to bundle a warning with the current quarter's earnings announcement as the amount of shares they sell in the two-week trading window immediately following the current quarter's earnings announcement increases. These findings suggest that managers rely on a subtle form of opportunism-simply remaining quiet, selling shares in this quarter's heavily trafficked, typically open trading window, and then waiting for the earnings disappointment to reveal itself next quarter-as opposed to engaging in the overtly opportunistic approach of selling shares just prior to supplying a warning about next quarter along with this quarter's earnings. This raises the question of whether the absence of incriminating trading, as opposed to the presence of a cautionary warning, drives reductions in litigation risk potentially attributed to warnings. Analyzing earnings-disclosurerelated lawsuits, we find that the absence of a warning combined with the presence of selling exacerbates the consequences associated with the individual behaviors. Yet, selling prior to a warning typically does not offset all of the warning's benefit. In so doing, we supply the first robust evidence of a litigation benefit associated with warning-even after considering the role that managers' trading behavior plays in shaping their disclosure decisions and influencing the firms' litigation consequences.

Disclosure of Financial Statement Line Items and Insider Trading Around Earnings Announcements

“…Post-earnings announcement trades are measured during the two-week period starting after the release of current quarter's earnings. This choice is to ensure that we capture the earnings-news-related selling, consistent with Billings and Cedergren (2015).…”

“…(Bettis et al 2000;Huddart et al 2007). Following the classification of trading windows by prior research (Billings and Cedergren 2015), Panel A presents the descriptive statistics for inside purchases by subperiod before earnings announcements, and Panel B presents the corresponding statistics for inside sales after earnings announcements.…”

“…See for example,Skinner (1994Skinner ( , 1997,Field et al (2005), andBillings and Cedergren (2015).8 The relative paucity of cash flow disclosures is likely due to the fact that cash flow disclosures during earnings announcements is a relatively recent phenomenon, as virtually no firms disclosed cash flows in the 1990s and early 2000s.…”

The Causes and Economic Consequences of Patent Litigation

“…Researchers have reported that many companies change their disclosure policies after being sued because they gaining a better understanding of the link between disclosure and litigation after going through the litigation process (Kothari et al, 2009;Ball et al, 2012;Billings and Cedergren, 2015). 6 Some researchers have shown a link between the quality of financial reporting, such as earnings management and restatements, and the risk of litigation (Palmrose and Scholz, 2004;Johnson et al, 2007;Cohen et al, 2008;Bardos et al, 2013).…”

Management Earnings Forecasts and Forward-Looking Statements

“…10 There are countless examples. Billings and Cedergren (2015) use the presence or absence of earnings forecasts to identify managers who stay silent ahead of earnings disappointments. Yang (2012) uses earnings forecasts to study manager-specific voluntary disclosure style.…”