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Legal Costs and Accounting Choices: Another Test of the Litigation Hypothesis

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  • William W. Stammerjohan
  • Steven C. Hall

Abstract

This paper provides another test of the litigation hypothesis proposed by Hall and Stammerjohan (1997) and provides evidence that subtle differences in the underlying business environment may be very important in predicting the accounting reaction of management to major events. The litigation hypothesis predicts that firms that are defendants in litigation with potentially large damage awards (major litigation) will attempt to reduce the size of those damage awards by making income‐decreasing accounting choices. The oil firms in the Hall and Stammerjohan study appeared to systematically reduce reported earnings during the litigation periods by under‐reporting new reserves. The fourteen chemical and pharmaceutical firms, involved in fifteen litigation events, examined by this study produce a very different result. The chemical and pharmaceutical firms faced a different business environment during their litigation periods and appear to have made income‐increasing accounting choices. These firms appear to have been able to perpetuate earnings growth without corresponding sales revenue growth during the litigation periods through unexpected reversals in deferred income tax expense.

Suggested Citation

  • William W. Stammerjohan & Steven C. Hall, 2003. "Legal Costs and Accounting Choices: Another Test of the Litigation Hypothesis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(5‐6), pages 829-862, June.
    • Handle: RePEc:bla:jbfnac:v:30:y:2003:i:5-6:p:829-862
    DOI: 10.1111/1468-5957.05418
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    Cited by:

    1. Anna Görlitz & Michael Dobler, 2023. "Financial accounting for deferred taxes: a systematic review of empirical evidence," Management Review Quarterly, Springer, vol. 73(1), pages 113-165, February.

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