An Unintended Benefit of the Risk Factor Mandate of 2005

Abstract

This study examines the effect of the Securities and Exchange Commission (SEC) 2005 risk factor disclosure mandate on firms’ willingness to provide forward-looking statements. The mandate resulted in an exogenous increase in legal protection for forward-looking statements for firms that had not previously disclosed their risk factors (named as late RF disclosers) because risk factor disclosures constitute “meaningful cautionary language” under the safe harbor provision of the Private Securities Litigation Reform Act. Using a difference-in-differences design, we compare late RF disclosers to firms that disclosed their risk factors prior to the mandate. Our results show that late RF disclosers become more willing to provide forward-looking statements, particularly positive ones, after the mandate. Using management forecasts as an alternative measure, we find that late RF disclosers are more willing to provide management forecasts and that their forecasts are more positive, have higher precision, and are of a longer horizon. Cross-sectional tests further show that this effect is stronger for firms whose forward-looking statements are more susceptible to potential litigation. Last, we find that late RF disclosers experience an improvement on the information environment relative to other firms, illustrating an unintended benefit of the 2005 risk factor mandate.

Keywords: Risk factor; Forward-looking statements; Safe harbor provision; Disclosure regulation

JEL Classification: M40, M41, M48, K22