شکایت های قانونی سهامدار، پیش بینی های مدیریت و تصمیمات سازنده در عرضه اولیه عمومی

This paper develops a model to analyze the impact of shareholder litigation on managers’ voluntary disclosure strategies in equity offerings. The major findings are as follows. First, under different economic parameters, the entrepreneur has two possible equilibrium disclosure strategies: full and partial disclosure. Of particular interest is the latter equilibrium, in which shareholder litigation can give the entrepreneur incentives to partially disclose her private information. Second, production decisions might be distorted by the entrepreneur’s disclosure incentives. The full disclosure equilibrium is associated with underinvestment, while overinvestment exists in the partial disclosure equilibrium. The model is then used to examine the effect of regulatory polices on firms’ disclosure incentives. It shows that relaxing the legal liability can result in more information flow to the public. However, it also leads to a higher rate of lawsuits and an increase in deadweight litigation costs.

One stylized fact about the initial public offerings (IPOs) in the United States is that equity-issuing firms rarely disclose any numerical forward-looking information (such as earnings or sales forecasts) (Clarkson and Simunic, 1994 and Lee et al., 2003). Two frequently cited reasons are the “quiet period” regulation and the threat of shareholder litigation. On one hand, the “quiet period” regulation forbids any disclosure of quantitative prospective information outside a statutory prospectus. Violation of the regulation is called “gun jumping” and could result in an order from the SEC to delay the effective date of the registration. On the other hand, the highly litigious legal environment inhibits the issuing firms from including forecasts in the prospectus (Mak, 1996 and Lee et al., 2003). That is, if a firm included a forecast in its prospectus and ultimately failed to meet it after the IPO, there could be a high risk of litigation. Due to these two factors, investors have very limited access to forward-looking information when they are making investment decisions. The policymakers have long been concerned with the insufficient communication in the equity offerings. In a securities offering reform proposal issued on November 3, 2004 (SEC Release 33-8501), the SEC requested public comments on several issues, including whether a safe harbor should be granted to IPO firms’ disclosure of forward-looking information, and whether the issuers should be required to provide projections in the registration statements.1 Motivated by these questions, this paper investigates the potential impact of shareholder litigation on the voluntary disclosure of forward-looking information in initial public offerings. It also analyzes the implications of disclosure legal liabilities for firms’ production decisions. Specifically, I introduce a potential cost of a lawsuit for the “failure to meet the forecast”. I assume that shareholders could hire a lawyer to file lawsuits against the equity-issuing firm if the subsequent actual performance falls below the management forecast disclosed during the offering. With an exogenous positive probability, the firm will end up settling the case and paying the shareholders for their damages. This positive probability is used to capture the litigiousness of the legal environment.2 The paper has the following major findings. First, under different sets of economic parameters, the entrepreneur has two possible equilibrium disclosure strategies: full disclosure and partial disclosure. Specifically, in a full disclosure equilibrium, the informed entrepreneur will always disclose her private signal when she issues equity; in a partial disclosure equilibrium, the entrepreneur will disclose only if her signal is above a certain threshold. Of particular interest is the latter equilibrium, in which shareholder litigation plays a significant role. The litigation threat can give the entrepreneur incentives to partially disclose her private prospective information. When the legal environment is sufficiently litigious, the entrepreneur rarely discloses forecasts in the offering, which is consistent with the situation in the United States. Second, the entrepreneur’s production decisions might be distorted by her disclosure incentives. In the full disclosure equilibrium, the entrepreneur, if informed, could give up some positive NPV projects if the expected litigation cost outweighs the expected investment profit. On the other hand, if she is uninformed and unable to issue a forecast, she has to forgo the investment opportunity even though the project is positive NPV, since the investors severely underprice the firm’s stock when they observe no disclosure.3 In contrast, in the partial disclosure equilibrium, the entrepreneur could invest in negative NPV projects. This is because when the investors have uncertainty about the entrepreneur’s information endowment, in equilibrium they overpay for the firm’s shares when the privately informed entrepreneur issues equity.4 Such overvaluation induces the entrepreneur to take on unprofitable projects and incur an efficiency loss. The model is then used to examine the effect of regulatory polices on firms’ disclosure incentives. The analysis shows that relaxing the legal liability (for example, by providing a safe harbor for forward-looking information disseminated by IPO firms) can result in more information flow to the public and facilitate the capital formation process. On the cost side, however, such a safe harbor could lead to a higher rate of lawsuits and an increase in deadweight litigation costs. As to the issue on whether to require issuing firms to file projections, the study suggests that the full disclosure policy is not necessarily optimal since it is associated with both a social loss due to underinvestment and a higher litigation-related deadweight cost. This paper extends previous analytical research on the link between shareholder litigation and managerial disclosure of prospective information. My study is most closely related to Trueman (1997), but my model differs from his in the following important ways. Trueman examines a setting in which the manager has an affirmative duty to disclose forward-looking information, and the failure to disclosure will potentially trigger lawsuits when there is a stock price decline after the actual result reveals the information that was withheld. But in my setting, the firm manager has no legal obligation to make a forecast and it is the disclosure of the prospective information that can lead to future lawsuits if the actual result falls below the forecast. Our results also differ significantly. Trueman demonstrates shareholder litigation can motivate managers to disclose bad news. In contrast, I show that litigation risk can suppress managerial disclosure of forward-looking information. My work also adds to the empirical literature on the relation between shareholder litigation and voluntary disclosure. Earlier studies (Skinner, 1997) investigate the impact of shareholder litigation on firm management’s voluntary disclosures of forecasts. Later, Johnson et al. (2001) examine how the safe harbor provision introduced by the 1995 Private Securities Litigation Reform Act changes the managers’ disclosure practices of prospective information. Baginski et al. (2002) compare the characteristics of management forecasts in two different legal environments – US and Canada. This line of research produces two general findings (as summarized in Baginski et al., 2002). First, the threat of litigation reduces the manager’s incentives to voluntarily disclose management forecasts. Second, fear of legal liability motivates managers to hasten disclosure of bad news to “preempt” potential lawsuits (e.g., Skinner, 1994). Almost all these studies examine management forecasts issued by existing public companies, while how litigation affects IPO firms’ disclosure incentives is largely unexplored. This could be attributable to the fact that IPO forecasts are virtually non-existent in the United States. My paper employs a theoretical approach and thereby circumvents the data problem. I argue that in the IPO settings shareholder litigation deters disclosure of prospective information rather than induces more disclosure. Furthermore, this approach also allows me to provide predictions for the potential consequences of alleviating the legal liability for forecasts associated with initial public offerings. In addition, this paper complements several empirical international studies on forecast disclosure by IPO firms in low-litigation countries including Australia (Lee et al., 2003), Canada (Jog and McConomy, 2003), and New Zealand (Mak, 1996). These studies document that earnings forecast disclosure is much more frequent in initial public offerings when the litigation risk is lower, and their evidence supports the idea that IPO firms use forecasts to reduce information asymmetry and forecast disclosure is informative and value-relevant. These findings are consistent with my theoretical predictions. This paper is organized as follows. The next section introduces the regulatory requirements on disclosure around equity offerings in the United States and the most recent development on securities offering reform. Then Section 3 introduces the basic settings of the model and the major assumptions, and briefly analyzes a benchmark case. Section 4 investigates the entrepreneur’s possible disclosure strategies if she is informed. Then the entrepreneur’s investment decisions in different disclosure equilibria (full and partial disclosure equilibria) are examined. Section 5 compares the ex ante efficiencies of different disclosure equilibria and discusses the policy implications of the results. The last section concludes.

I conclude the paper with the following remarks. First, one major limitation of this paper is that I assume disclosure is truthful if the entrepreneur ever discloses. Even though this assumption is warranted by the integrity requirements on the IPO prospectus, the possibility of lying can still arise if the legal liability for forward-looking information is relaxed and firms start to issue projections. Therefore, an interesting extension of the analysis is to draw on cheap-talk or persuasion game models to introduce untruthful reporting, and reinvestigate the effect of shareholder litigation on IPO firms’ voluntary disclosure incentives and the potential consequences of providing a safe harbor for IPO forecasts. On the other hand, the regulators can introduce a number of reporting requirements to ensure the credibility of forecasts. For example, if a firm includes a forecast in the IPO prospectus, it should also disclose the principal assumptions in forecasting and also provide an auditor’s review of the forecast (Mak, 1994 and Lee et al., 2003). Secondly, I assume that capital markets are competitive and investors are rational. As a result, the investors are indifferent to different liability rules on disclosure since they are assumed to always break even in the equilibrium and it is the entrepreneur who ultimately bears all the consequences of the change in the legal system. To the extent that this assumption is not descriptive of the real world, I could underestimate the potential benefits of providing a safe harbor to induce more managerial disclosure of forward-looking information. Third, I assume that the only sources of information for the investors are the public report, the entrepreneur’s disclosure, and her investment decision. That is, I do not allow for the possibility that the investors could have access to alternative information sources, or the entrepreneur could convey her private information through other mechanisms (underwriter reputation or auditor quality). I believe that this assumption is valid as long as the investors could not fully infer or uncover the entrepreneur’s private information. Direct disclosure can be important if it is incrementally informative beyond all the other information. In addition, if other disclosure mechanisms are more costly, direct disclosure can have a positive role in the economy. Finally, one salient feature of this paper is that I explicitly model shareholder litigation and its role in affecting issuing firms’ incentive to disclose prospective information. However, the probability that the firm will settle the lawsuit (the measure of the litigation risk) is assumed to be an exogenous constant, which could actually be a function of the magnitude of the forecast error. Richer insights may be obtained if these elements are incorporated.