An Unintended Benefit of the Risk Factor Mandate of 2005

Abstract

This study documents an unintended effect of the SEC mandate for risk factor disclosure on firms’ willingness to provide forward-looking statements (FLS). In 2005, the SEC began mandating that firms disclose risk factors in order to provide investors with useful information on firm risk. Although not intended by the SEC, the mandatory risk factor disclosure potentially constitutes “meaningful cautionary language” of the Private Securities Litigation Reform Act, providing legal protection for FLS. We hypothesize that the mandate reduces managers’ perceived litigation risk in providing FLS at firms that had not previously disclosed risk factors (late RF disclosures). Using both difference-in-differences design and two-stage least square approach, we find that late disclosures became more willing to provide FLS than other firms, particularly positive ones. We also find that late disclosures became more willing to provide management forecasts and that these forecasts are more positive, more precise, and are of a longer horizon. Cross-sectional tests further show that this effect is stronger for firms whose managers perceive a higher level of legal benefit from meaningful cautionary statements. Last, we find that late RF disclosures experience an improvement in the information environment, illustrating an unintended benefit of the 2005 risk factor mandate.

Keywords: risk factor disclosure; safe harbor provision; forward-looking statements; disclosure regulation

JEL Classification: K22; M41; M43