The moderating role of firms’ litigation environment on the association between gender diversity and financial reporting quality

Purpose - This paper examines the moderating role of firms’ litigation environment on the association between gender diversity and financial reporting quality. Design/methodology/approach - This study draws on a sample of US firms to examine the moderating role of firms’ litigation environment on the association between gender diversity and financial reporting quality. Firm-specific financial data come from Compustat. To measure the firms’ litigation environment, we use state-level datasets from the Lawsuit Climate Survey conducted for the US Chamber Institute for Legal Reform by the Harris Poll. Findings - Findings suggest that firm litigation environment moderates gender diversity, as defined by female members on the board to subdue our first proxy for financial reporting quality (accruals-based earnings management), but our second proxy for financial reporting quality (real-activities manipulations) increases in a firm’s litigation environment. To the extent that our results hold after controlling for firms’ reputation indicates that female members on the board are sensitive to reputational loss and protect firms’ reputation in a litigation environment. Research limitations/implications - The study is based on a specific country, limiting the generalizability of the findings. Practical implications - The findings provide support for promoters and advocates of gender diversity in corporate boards. Specifically, it shows the importance of gender diversity policies in business and society. Originality/value - This study is the first to examine the moderating role of firms’ litigation environment on the association between gender diversity and financial reporting quality. The study provides novel evidence and shows that the litigation environment moderates gender diversity to improve financial reporting quality in the short-term (by decreasing accruals manipulation). In firms’ litigation environment, when female members on the board are restrained from engaging in accruals earnings management, they shift to value-destroying and costly real activities to maintain reputation and firm performance. To the extent that we control for the potential effects of firms’ reputation and financial performance, our findings suggest that ethical concerns are likely to drive female members on the board to produce high-quality financial reports.