The Information Content of Mandatory Risk Factor Disclosures in Corporate Filings PDF Download

Author: John L. Campbell
Publisher:
ISBN:
Category :
Languages : en
Pages : 61

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Book Description
Beginning in 2005, the 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.” This suggests that regulators believe that investors benefit from disclosures about firm risk and uncertainties. Critics argue that the disclosures are qualitative and boilerplate, and thus uninformative. In this study, we examine the information content of this newly-created risk factor section and offer two main results. First, we find that firms that face greater risk disclose more risk factors, and that the type of risk that a firm faces (i.e. systematic, idiosyncratic, financial, legal, or tax) determines whether they devote a greater portion of their disclosures towards describing that risk type. In other words, managers provide informative risk factor disclosures. Second, we find that market participants incorporate the information conveyed by risk factor disclosures into their assessments of firm risk and stock price, and that the public availability of the disclosure decreases information asymmetry amongst firms' shareholders. We are the first study to document that when managers increase negative/pessimistic qualitative disclosure, market-based measures of firm risk increase. These results provide further insight into the relationship between disclosure and firm risk, and may inform current policy decisions of the SEC.

Author: Richard A. Cazier
Publisher:
ISBN:
Category :
Languages : en
Pages : 69

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Although formal guidance instructs firms to avoid issuing lengthy and boilerplate risk factor disclosures, regulators and users of financial statements note these disclosures continue to be excessively long and boilerplate. The persistence of these characteristics is particularly surprising given that prior research finds firms disclosing lengthy and boilerplate risk factors experience negative capital market consequences. We investigate two potential sources of firms' incentives to issue such disclosures by examining how judicial and regulatory assessments of firms' risk factor disclosures correlate with measures of disclosure length and disclosure boilerplate. Our results suggest that lengthier and more boilerplate risk factor disclosures are less likely to be considered inadequate under judicial and regulatory review. Specifically, risk factors that are lengthier and less specific are less likely to be found inadequate by judges in shareholder securities lawsuits. In addition, more standardized risk factor disclosures are less likely to be targeted by an SEC comment letter during the SEC's filing review process. Further analysis finds that when risk factor language is assessed as adequate in judicial review, industry peers borrow that language more frequently. Finally, we find that judicial assessments of risk factor disclosures prompt industry peers to lengthen their own risk factor disclosures regardless of whether the risk disclosure was deemed adequate or not.

Author: Joshua Filzen
Publisher:
ISBN:
Category :
Languages : en
Pages : 35

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Prior research has documented that the market responds to quarterly updates to annual risk factor disclosures at the time of release, suggesting quarterly risk factor updates provide informational value to investors. In this study, we examine whether future returns are associated with quarterly risk factor updates. We find that firms with quarterly risk factor updates experience lower future returns, relative to firms without updates. Further, we find that firms that shy away from language indicating risk to firm fundamentals in a quarterly risk factor update exhibit the strongest predictability of future returns. This result suggests that the content of an update is related to the completeness of the market reaction at the time the 10-Q is filed. This research is of direct interest to investors and regulators who are currently considering how to improve risk factor disclosure requirements.

Author: Joshua Filzen
Publisher:
ISBN:
Category :
Languages : en
Pages :

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I examine whether recently required risk factor update disclosures in quarterly reports provide investors with timely information regarding potential future negative economic events. Specifically, I examine whether risk factor updates in 10 Q filings are associated with negative abnormal returns at the time the updates are disclosed and whether quarterly updates are followed by negative earnings shocks. I find that firms presenting updates to their risk factor disclosures have significantly lower abnormal returns around the filing date of the 10 Q relative to firms without updates. I also find that firms with updates to their risk factors section have significantly lower future unexpected earnings and are more likely to experience future extreme negative earnings shocks. These findings suggest that the recent disclosure requirement mandated by the SEC was successful in generating timely disclosure of bad news.

Author: Anne Beatty
Publisher:
ISBN:
Category :
Languages : en
Pages : 58

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Book Description
The SEC's Disclosure Effectiveness Initiative (December 2013) highlights a difference between accounting regulators and academics in their perceptions of Item 1A risk factor disclosure effectiveness. Because most academic evidence relies on pre-financial crisis data, we compare changes in risk factor disclosure informativeness before and after the crisis as a possible explanation for this disconnect. We further explore this discrepancy by considering i) three classes of market participants, ii) new, discontinued, and repeated disclosures, and iii) non-market outcomes. Our results confirm previous findings but indicate that those results no longer hold in the subsequent period. Specifically, we find that although equity, option, and bond markets react to unexpected risk factor disclosures in the period leading up to the financial crisis (2006-2008), the market reactions decline significantly in the post-crisis period (2009-2014). Perhaps surprisingly, the documented changes in informativeness are not driven by disclosures repeated from one year to the next but instead result from new disclosures initiated in the current year and, in the option and debt markets, also from disclosures discontinued from the previous year. Finally, using the Altman Z-score as an objective bankruptcy risk measure, we find that the association between risk factor disclosures and companies' future bankruptcy risk declines significantly in the post financial crisis period. Taken together, these findings contribute to the current disclosure effectiveness debate by highlighting that risk factor disclosures, which were informative in the preceding period, become less reflective of the underlying economic risks and thus less informative to investors in the post-crisis period.

Author: Abiodun Isiaka
Publisher:
ISBN:
Category :
Languages : en
Pages : 47

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Book Description
The purpose of this paper is to synthesize the current literature on Risk Factor Disclosures (RFDs) and propose a framework for future research. Beginning in 2005, the US Securities and Exchange Commission (SEC) proposed changes to the disclosure of risk information in the annual 10-K reports. These changes mandated large firms in the US to disclose risk factors in a specific section of their 10-Ks, referred to as Item 1A. This paper identifies and suggests research questions in four areas to improve usefulness of RFD reporting: RFDs topics and content, RFDs usefulness to investors, RFDs usefulness in contractual settings, and market-wide usefulness of RFDs. This study will be of use to academic research on the usefulness of RFDs and will provide information to the SEC on ways to improved RFDs.

Author: Keehea Moon
Publisher:
ISBN:
Category :
Languages : en
Pages : 73

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Book Description
The SEC mandates that firms disclose material risk factors in their annual reports and adopts a principles-based approach, which allows managers to exercise discretion in determining which risks are material and the extent to which these risk factors are disclosed. To investigate whether risk factor disclosures reflect what managers consider to be material risks as the SEC intended, I examine manager-specific factors as a determinant of the content of risk factor disclosures. Specifically, I propose that managers have different risk perceptions that affect their assessment of material risks and ultimately the disclosure outcomes. Using a fixed effects approach, I find that individual managers have a significant effect on both the quantity and quality of risk factor disclosures after controlling for time varying firm characteristics, reporting incentives, firm fixed effects, and time fixed effects. Further, I examine managerial overconfidence, a managerial bias that is related to how managers perceive risks, and find that more overconfident managers disclose fewer risk factors and provide lower quality risk factor disclosures. Finally, I find that firms with more overconfident managers are more likely to receive a SEC comment letter on their risk factor disclosures. Overall, my findings suggest that manager-specific factors have a significant influence on the textual content of an important mandatory disclosure.

Author: Ole-Kristian Hope
Publisher:
ISBN:
Category :
Languages : en
Pages : 60

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Book Description
Practitioners have long criticized risk-factor disclosures in the 10-K as generic and boilerplate. In response, regulators emphasize the importance of being specific. By using a computing algorithm, this paper establishes a new measure (Specificity) to quantify the level of specificity of firms' qualitative risk-factor disclosures. We first examine determinants of variations in Specificity and document that firms with high proprietary costs provide less specific risk-factor disclosures. More importantly, we find that, controlling for numerous determinants, the market reaction to the 10-K filing is positively and significantly associated with Specificity. In addition, our results suggest that analysts are better able to assess fundamental risk when firms' risk-factor disclosures are more specific. Together, these findings suggest that more specific risk-factor disclosures benefit users of financial statements.

Author: United States. Securities and Exchange Commission. Office of Investor Education and Assistance
Publisher:
ISBN:
Category : Disclosure of information
Languages : en
Pages : 88

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Book Description

Author: John L. Campbell
Publisher:
ISBN:
Category :
Languages : en
Pages : 57

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Book Description
Prior research finds that mandatory risk factor disclosures are informative in that they increase investors' assessments of the volatility of a firm's cash flows. However, the literature is silent as to whether these disclosures provide information about the level of future cash flows and, ultimately, their implications for firm value. We address this question by examining the association between Form 10-K risk factor disclosures and future cash flows levels and stock returns. We use the setting of taxes because it is relatively easier to identify the specific income and cash flow statement line items to which these risks relate, and offer two main results. First, we find that tax risk factor disclosures are positively associated with future cash flows. This suggests that, on average, tax risk factor disclosures relate to tax positions that are rewarded with future tax savings. Second, we find that investors incorporate this relation into stock prices. In additional analysis, we find no evidence of a drift in stock prices, suggesting that investors incorporate the implications of tax risk factor disclosures in a timely manner. Overall, our results suggest that risk factor disclosures provide information about the level of a firm's future cash flows, that the risks discussed in these disclosures are - on average - value-increasing, and that investors incorporate this information into current stock prices.