Legal costs and accounting choices: Another test of the litigation hypothesis

Abstract

The evidence provided in this study does not support the litigation hypothesis proposed by Hall and Stammerjohan (1997). We find no evidence that the chemical and pharmaceutical firms faced with major litigation made income-decreasing accounting choices during their litigation periods. In light of the evidence that firm wealth and profitability play a significant role in determining the size of damage awards and/or settlements, and in light of the Hall and Stammerjohan (1997) evidence, our results are at first surprising. The size of the settlements and original suits in our chemical and pharmaceutical sample, and the documented uncertainty regarding potential damage awards, all indicate that the managers of the chemical and pharmaceutical firms in our test sample had incentives to make income-decreasing accounting choices. © Blackwell Publishing Ltd 2003.