Litigation Risk and Management Forecast Optimism: Is Bad News Really Less Biased Than Good News?

This study investigates whether litigation risk is higher on good news than on bad news management forecasts, resulting in lower bias in good news than in bad news. Consistent with my expectation, I find that litigation risk reduces the optimistic bias in good news but not that in bad news management forecasts. I attribute this finding to the asymmetric suing difficulty faced by investors and distinct stock price patterns following good and bad news forecasts. In contrast to the conventional view that good news is inherently upward biased and bad news is trustworthy due to firms' lack of incentives to deflate their stock prices, I find that bad news management forecasts are more optimistically biased than their good news counterparts. These findings hold only for the post-RegFD period. Litigation risk prior to RegFD is not sufficiently high to affect managers' forecasting behavior. In addition, RegFD reduces the optimism in good news but not that in bad news management forecasts, consistent with my hypothesis that litigation risk is higher on good news than bad news forecasts. Last, I present evidence that is inconsistent with investors perceiving bad new as less biased than good news as claimed in some prior studies.