Securities class action lawsuits allow investors to recuperate investment losses caused by securities law violations. They are arguably the most significant litigation risk for firms listed in the United States and other major economics such as U.K., Australia and Canada. In these lawsuits, shareholders usually allege that company management defrauds investors by providing misleading statements or omitting material information. Many such lawsuits involve forward-looking information issued by the company such as new products, new markets and earnings guidance.

We take advantage of a mandate that requires firms to provide risk factor disclosure and find that, following the mandate, firms that had not previously disclosed risk factors became more willing to provide qualitative FLSs, particularly positive ones, than other firms. Further analyses show that this increased willingness to disclose is likely due to managers taking advantage of the safe harbor protection arising from the risk factors. We also find that these firms experience improvement in their information environment, illustrating an unintended benefit of the risk factor mandate.

Our research has implications for regulators by showing that regulations can have unintended consequences—that is, although regulators intend to supply investors with information about firm risk, firms prepare risk factor disclosures in a manner that exploits their legal benefits. This incentive leads firms to include large, seemingly boilerplate passages in their filings and prompts them to provide more forward-looking information.

Our research also has important implications for firms that are listed in stock exchanges in countries that allow securities class action lawsuits, for example, the United States. Due to investor demands, firms routinely discuss future plans such as new products, new markets, and issue earnings guidance. Despite the safe harbor provision, such disclosures remain the prime target of plaintiff complaints and lead to adverse litigation outcomes. Many firms that primarily operate in emerging markets are unfamiliar with legal regimes that allow securities class action lawsuits and ill equip to handle these lawsuits. Our recommendation is that firms that consider listing in these regimes should provide sufficient risk factor disclosure to avoid becoming targets in these lawsuits.