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Unintended consequences of lowering disclosure thresholds: Proposed changes to SFAS No. 5
Recently, investors have asserted that firms' loss contingency disclosures are not adequate to allow them to assess the likelihood of material losses due to litigation (i.e., litigation risk), and a debate has developed over whether the threshold for disclosure should be lowered to provide investors with more information relating to litigation. Using an experiment, I investigate two unintended consequences of lowering a disclosure threshold, as the FASB has recently proposed. First, I find that adding low probability lawsuits to the disclosure of reasonably possible lawsuits lowers prospective investors' perceptions of litigation risk relating to the disclosure, even though more lawsuits are disclosed. Second, lowering the threshold allows firms to portray the entire disclosure opportunistically, diverting attention from higher probability to lower probability lawsuits. I find evidence that firms can use such an opportunistic presentation under a lower threshold to their advantage. Specifically, prospective investors' and even short investors' perceptions were just as favorable to the firm as long investors' when the disclosure threshold was lower and firms adopted an opportunistic disclosure strategy. Thus, my findings suggest that the FASB's proposal to require disclosure of lower probability loss contingencies may have unintended consequences for investors' perceptions of firms' loss exposure.
Fanning, Kirsten, "Unintended consequences of lowering disclosure thresholds: Proposed changes to SFAS No. 5" (2011). Doctoral Dissertations Available from Proquest. AAI3445156.