Discretionary Risk Disclosures

Abstract

We model managers' equilibrium strategies for voluntarily disclosing information about their firm's risk. We consider a multifirm setting in which the variance of each firm's future cash flow is uncertain. A manager can disclose, at a cost, this variance before offering the firm for sale in a competitive stock market with risk-averse investors. In our partial disclosure equilibrium, managers voluntarily disclose if their firm has a low variance of future cash flows, but withhold the information if their firm has highly variable future cash flows. We establish how the manager's discretionary risk disclosure affects the firm's share price, expected stock returns, and beta, within the framework of the Capital Asset Pricing Model. We show that whereas one manager's discretionary disclosure of his firm's risk does not affect other firms' share prices, it does affect the other firms' betas. Also, we demonstrate that a disclosing firm has lower risk premium and beta ex post than a nondisclosing firm. Finally, we show that ex ante, the expected risk premium and expected beta of each firm are higher under a mandatory risk disclosure regime than in the partial disclosure equilibrium that arises under a voluntary disclosure regime.

The Association Between the Disclosure and the Realization of Information Security Risk Factors

“…Disclosure may also be used to reduce ex post legal and reputation costs from bad news, or when the firm faces earnings disappointments (e.g., Skinner 1994; Kasznik and Lev 1995;Field et al 2005). Specific to risk disclosures, one recent study by Jorgensen and Kirschenheiter (2003) formally models managers' decisions on voluntarily disclosing a firm's risks, and they find that firms with smaller future uncertainty will choose to disclose risk factors. Additionally, studies have focused on the quality and credibility of the disclosures (e.g., Lang and Lundholm 1993;Penno 1997;Stocken 2000), the usefulness of disclosures (e.g., Francis et al 2002;Landsman and Maydew 2002), and other aspects of voluntary disclosures such as expectation adjustment, costs, analysts following, and signaling rationale (e.g., Lev and Penman 1990;Lang and Lundholm 1996).…”

Determinants of narrative risk disclosures in UK interim reports

“…Despite of recent increase in risk research, prior CRD studies focused on CRD determinants in the annual reports (Abraham and Cox, 2007;Beretta and Bozzolan, 2004;Hassan, 2009;Lajili and Zéghal, 2005;Linsley and Shrives, 2000, 2005Weetman, 2002 andRajab and Handley-Schachler, 2009;Elshandidy et al, 2011;Vandemaele et al, 2009) and/or for companies listed in regulated risk reporting environments (Hodder and McAnally, 2001;Kirschenheiter, 2003 andJorion;2002;Linsmeier et al, 2002;Rajgopal, 1999). Our paper aims at investigating the factors affecting CRD in UK interim reports.…”

A theory of voluntary disclosure and cost of capital

“…My paper combines voluntary disclosure with asset pricing in the presence of systematic risk. To my knowledge, the only papers that focus on voluntary disclosures and systematic risk are those of Kirschenheiter andJorgensen (2003, 2007). They focus on disclosures about risk, more applicable to financial products, such as value-at-risk, new ventures, exposure to interest rates.…”

“…As is common in the voluntary disclosure literature, I consider disclosures about expected or projected cash flows, such as asset values, earnings' forecasts, sales projections, expense reductions or asset acquisitions. While Kirschenheiter andJorgensen (2003, 2007) do not compute the average cost of capital (average return by all firms), they find that the equity risk premium (return on the market portfolio) is increasing in information availability. 5 They note that these effects should become (arbitrarily) small in a large economy if the disclosure is about the asset's variance (Jorgensen and Kirschenheiter (2003)) but hold in a large economy if the disclosure is about sensitivity to systematic risk (Jorgensen and Kirschenheiter (2007)).…”