How Shareholder Accusations of Managerial Misconduct Affect Sell-side Analysts

Abstract

In this paper, I examine how the firm's information environment changes after an accusation of managerial misconduct associated with management disclosure. Filing a security class action lawsuit under SEC Rule 10(b)-5 is the primary mechanism that shareholders have to formally accuse management of intentionally misrepresenting or withholding firm disclosure. After the filing of the lawsuit, investors and other market participants likely question management's credibility and the quality of its disclosure. Investors likely demand additional information from other market participants to evaluate and/or substitute for management disclosure after the lawsuit is filed. I argue that sell-side equity analysts have the expertise and incentives to produce a portion of the additional information demanded by investors after the filing of the lawsuit. Using 565 security class action lawsuits obtained from Cornerstone Research and Stanford Law School, I find evidence consistent with sell-side analysts providing more services, using more private information during the forecasting process, and having more informative reports after the filing of a security class action lawsuit.