Accounting Choices and the Legal Environment: The Impact of the Ex Post Loss Rule

Using a landmark Supreme Court decision as a natural experiment, I examine the impact of a fundamental requirement in securities litigation - the ex post loss rule on income-decreasing accounting choices. Dura Pharmaceuticals v. Broudo (2005) established that plaintiffs must show that the alleged misrepresentations caused an actual economic loss. The case resolved a circuit split, allowing me to identify a treatment jurisdiction affected by Dura, and control jurisdictions in which the rule was already the prevailing legal standard. Motivated by legal analyses suggesting that Dura incentivizes firms to withhold or delay negative corrections, I hypothesize and find that treatment firms in high-litigation industries became more likely to delay write-downs and avoid income-decreasing accrual error reversals at the firm level after Dura, relative to matched control firms. This study sheds light on the relationship between securities law and accounting practices, and informs policy makers on the accounting impact of a key feature of the legal environment.