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Technology companies and accounting lawsuits II

Yesterday, Walter repeated Larry Ribstein's question: "The fact that a particular industry is especially subject to lawsuits by its very nature would seem to be a problem, unless there's something inherently wrong with the industry. Why should we want to subject tech companies to a litigation tax?"

But there are probably some good economic reasons for tech companies to be more susceptible to accounting fraud lawsuits, reasons that would account for some (though probably not all) of the observed difference.

1) Tech companies are much more likely than average to have outsized valuations tied to perceptions of revenue growth;
2) Tech companies are somewhat more likely than average to have executive compensation heavily tied to stock options;
3) Tech companies are more likely than average to be acquisition targets (or acquirers) in stock deals where short-term fluctuations in the stock price have long-term effects on the company's prospects;
4) There was also a stretch of time in the boom years where tech company executives were more likely to be fly-by-night and/or inexperienced. (See, for example, Lori Gottlieb's Inside the Cult of Kibu.)

If these perceptions are true, there would be a greater incentive for tech company executives to fiddle with the books, both in terms of expected benefit from the fraud and, in at least some cases, decreased costs of exposure (compared to the opportunity cost of being a failed tech company executive), which one would expect to increase the real fraud worthy of suit.

A testable hypothesis: are companies with with high price-to-revenue ratios more likely to have committed fraud?

Of course, these same reasons also create the effect of minor unintentional accounting mistakes (or missed revenue targets) having a greater chance of having material effects on stock prices, increasing the likelihood of being the target of profession litigation factories.



Rafael Mangual
Project Manager,
Legal Policy

Katherine Lazarski
Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.