A Theory of Risk Disclosure

47 Pages Posted: 24 Jul 2015 Last revised: 10 Jun 2017

See all articles by Mirko Stanislav Heinle

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department

Kevin Smith

Stanford University Graduate School of Business

Date Written: May 30, 2017

Abstract

In this paper, we consider the price effects of risk disclosure. We develop a model in which investors are uncertain about the variance of a firm's cash flows and the firm releases an imperfect signal regarding this variance. In our model, uncertainty over the riskiness of a firm's cash flows leads to a variance uncertainty premium in its price. We demonstrate that risk disclosure decreases the firm's cost of capital by reducing this premium and that the market response to risk disclosure is small when the expected level of risk is high. Moreover, we find that firms acquire and disclose more risk information when their cash flow risk is greater than expected. Finally, we demonstrate that in a multi-asset setting, only risk disclosure concerning systematic risks will impact the cost of capital.

Keywords: disclosure, variance uncertainty

JEL Classification: G11, G12, M40

Suggested Citation

Heinle, Mirko Stanislav and Smith, Kevin, A Theory of Risk Disclosure (May 30, 2017). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2635074 or http://dx.doi.org/10.2139/ssrn.2635074

Mirko Stanislav Heinle (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Kevin Smith

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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