An Unintended Benefit of the Risk Factor Mandate of 2005

Abstract

In 2005, the SEC began mandating that firms disclose risk factors to provide useful information on firm risk. Although not intended by regulators, mandatory RF disclosure may constitute “meaningful cautionary language” as defined in the Private Securities Litigation Reform Act, providing legal protection for forward-looking statement (FLS). Using both a difference-in-differences design and a two-stage least squares approach, we find that firms that had not previously disclosed risk factors (late RF disclosers) became more willing to provide qualitative FLS, particularly positive ones, than other firms, consistent with the mandate reducing managers’ perceived litigation risk in late RF disclosers. Cross-sectional tests show that this effect is stronger for firms whose managers perceive a higher level of benefit from safe harbor protection availed by the provision of meaningful cautionary statements. Last, we find that late RF disclosers experience improvement in their information environment, illustrating an unintended benefit of the 2005 RF mandate.

Keywords: risk factor disclosure; safe harbor provision; forward-looking statements; voluntary disclosure; qualitative disclosure; information environment

JEL Classification: K22; M41; M43