Risk Factor Disclosures and Accounting Conservatism
50 Pages Posted: 10 Jan 2019 Last revised: 26 Mar 2019
Date Written: January 9, 2019
This study examines the relation between narrative risk disclosures and accounting conservatism by utilizing the SEC’s 2005 mandate that firms disclose “the most significant factors that make the company speculative or risky” in their 10-K filings. By viewing such risk factor disclosures (RFDs) as an integral part of financial reporting and disclosure, I hypothesize that RFDs likely affect firms’ financial reporting choice in accounting conservatism in two ways, the substitutive effect and the stimulative effect. On the one hand, RFDs may substitute for conservatism by revealing important information that may partly meet the contracting and litigation demands for conservatism. On the other hand, RFDs may stimulate a greater level of conservatism by increasing the level of risk perceived by financial statement users, who in turn may demand more conservative reporting. My results are consistent with the substitutive effect, as firms report less conservatively after RFDs are included in their 10-K filings. I conduct additional content analysis and show that firms providing more specific RFDs tend to report more conservatively; whereas, firms providing RFDs with a tone of greater uncertainty tend to report less conservatively. My findings highlight the importance of evaluating narrative risk disclosures as part of the whole information package produced by the firm, rather than as a stand-alone additional piece of information.
Keywords: Risk factor disclosures, Accounting conservatism, Textual analysis
JEL Classification: M41
Suggested Citation: Suggested Citation