Federal Judge Ideology: A New Measure of Ex Ante Litigation Risk

ALLEN HUANG, KAI WAI HUI, REEYARN ZHIYANG LI

Journal of Accounting Research · 2019 · Volume 57 · Issue 2

Abstract

Drawing on the political theory of judicial decision making, our paper proposes a new and parsimonious ex ante litigation risk measure: federal judge ideology. We find that judge ideology complements existing measures of litigation risk based on industry membership and firm characteristics. Firms in liberal circuits (the third quartile in ideology) are 33.5% more likely to be sued in securities class action lawsuits than those in conservative circuits (the first quartile in ideology). This result is stronger after the U.S. Supreme Court's ruling in theTellabscase. We next show that the effect of judge ideology on litigation risk is greater for firms with more sophisticated shareholders and with higher expected litigation costs. Furthermore, judicial appointments affect litigation risk and the value of firms in the circuit, highlighting the economic consequences of political appointments of judges. Finally, using our new measure, we document that litigation risk deters managers from providing long-term earnings guidance, a result that existing measures of litigation risk cannot show.

Keywords

K22, K40, K41, securities litigation, litigation risk, federal courts, judge ideology

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