The Unintended Benefit of the Risk Factor Mandate of 2005

Review of Accounting Studies, Forthcoming

72 Pages Posted: 9 Aug 2018 Last revised: 5 Mar 2021

See all articles by Allen Huang

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting

Jianghua Shen

Xiamen University

Amy Zang

Hong Kong University of Science and Technology - Department of Accounting

Date Written: December 5, 2020

Abstract

In 2005, the SEC mandated that firms disclose risk factors to provide useful information about firm risk. An unintended effect of the mandate is that mandatory risk factor (RF) disclosure may constitute “meaningful cautionary language” as defined in the Private Securities Litigation Reform Act, and may therefore provide legal protection for forward-looking statements (FLSs). Using both a difference-in-differences design and a two-stage least squares approach, we find that, following the mandate, firms that had not previously disclosed risk factors (late RF disclosers) became more willing to provide qualitative FLSs, particularly positive ones, than other firms. This finding is consistent with our prediction that, for late RF disclosers, the mandate reduces managers’ perceived litigation risk. We also find that these firms experience improvement in their information environment. A path analysis reveals that the mandate improves firms’ information environment not only directly but also indirectly by prompting more disclosure of positive FLSs, illustrating an unintended benefit of the 2005 RF mandate. Cross-sectional tests show that the RF mandate induces a larger increase in positive FLSs for firms whose managers perceive a higher level of benefit from safe harbor protection arising from meaningful cautionary statements.

Keywords: Risk factor disclosure; Litigation risk; Forward-looking statements; Voluntary disclosure; Information environment

JEL Classification: K22; M41; M43

Suggested Citation

Huang, Allen and Shen, Jianghua and Zang, Amy, The Unintended Benefit of the Risk Factor Mandate of 2005 (December 5, 2020). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3219712 or http://dx.doi.org/10.2139/ssrn.3219712

Allen Huang (Contact Author)

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong

HOME PAGE: http://www.AllenHuang.org

Jianghua Shen

Xiamen University ( email )

Xiamen, Fujian 361005
China

Amy Zang

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
Clear Water Bay, Kowloon
Hong Kong
+852-23587561 (Phone)

HOME PAGE: http://www.AmyZang.org

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