The information content of mandatory risk factor disclosures in corporate filings
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Beginning in 2005, the Securities and Exchange Commission (SEC) mandated firms to include a “risk factor” section in their Form 10-K to discuss “the most significant factors that make the company speculative or risky.” In this study, we examine the information content of this newly created section and offer two main results. First, we find that firms facing greater risk disclose more risk factors, and that the type of risk the firm faces determines whether it devotes a greater portion of its disclosures towards describing that risk type. That is, managers provide risk factor disclosures that meaningfully reflect the risks they face. Second, we find that the information conveyed by risk factor disclosures is reflected in systematic risk, idiosyncratic risk, information asymmetry, and firm value. Overall, our evidence supports the SEC’s decision to mandate risk factor disclosures, as the disclosures appear to be firm-specific and useful to investors.
KeywordsTextual analysis Risk disclosures Disclosure tone Regulation Information content
JEL ClassificationD8 G24 G12 M4
We are grateful for the helpful comments and suggestions of an anonymous reviewer, Kris Allee, Terry Baker, Liz Chuk, James Cotter, Jon Duchac, Fabio Gaertner, Ronen Gal-Or, Andrea Kelton, Feng Li, Russell Lundholm, Bill Marcum, Dale Martin, Rick Mergenthaler, Karen Nelson, Deon Strickland, Jake Thornock, the doctoral students at the University of Arizona, workshop participants at Wake Forest University, and conference participants at the 2011 AAA Annual Meeting and the 22nd Annual Conference on Financial Economics and Accounting (FEA) at Indiana University. Finally, we thank both the Securities and Exchange Commission (SEC) and the Institute of Chartered Accountants in England and Wales (ICAEW) for their interest in this paper. Portions of this paper were included in the ICAEW’s October 2011 report titled “Reporting Business Risks: Meeting Expectations.” Professor Lu gratefully acknowledges assistance from the National Science Council of Taiwan (grant number NSC100-2410-H-002-025-MY3).
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