Are Firms Biasing Stakeholder Expectations by Attributing Prior Poor Performance to COVID-19?

Desai, H. (2021). Are firms biasing stakeholder expectations by attributing prior poor performance to COVID-19?. IIM Kozhikode Society & Management Review. Available at https://doi.org/10.1177/22779752211061207

1 Pages Posted: 5 Nov 2021 Last revised: 23 Mar 2022

Date Written: July 1, 2021

Abstract

Item 503(c) of the United States Securities and Exchange Commission’s (SEC’s) Regulation S-K requires firms to disclose the ‘most significant’ factors that affect them in their Item 1A risk factor disclosures made in their 10-K (annual) or 10-Q (quarterly) SEC filings. Prior to COVID-19, firms discussed risk factors such as liquidity, competition, etc. as part of their Item 1A disclosures. The current pandemic has resulted in the COVID-19 risk factor being widely discussed as part of firms’ Item 1A risk factor disclosures. A ‘firm-specific’ discussion on this transient risk factor is unique in the sense that it can affect the salience of other, already disclosed, less transient but significant risk factors to investors and other stakeholders. Using a sample of 68 firms hard hit by COVID-19 with prior poor performance, I find that market reactions to their Item 1A risk factor disclosures were significantly more positive for firms that disclosed the COVID-19 risk factor in a certain firm-specific manner compared to those that didn’t. These results suggest that stakeholder perceptions of firms’ risk profiles are being biased to some extent as the less transient but other significant risk factors that were already affecting these firms seem to be underweighted by them in evaluating the firms’ risk profiles. I explain this bias further using the meta-theoretical framework of the elaboration likelihood model. I also propose a solution to this problem that involves making these disclosures in the form of risk matrices.

Keywords: COVID-19, financial disclosures, firm performance, judgement bias, risk factor disclosures, risk analysis, SEC regulations, elaboration likelihood model

JEL Classification: G38, M10, M40, M41, M48

Suggested Citation

Desai, Hrishikesh, Are Firms Biasing Stakeholder Expectations by Attributing Prior Poor Performance to COVID-19? (July 1, 2021). Desai, H. (2021). Are firms biasing stakeholder expectations by attributing prior poor performance to COVID-19?. IIM Kozhikode Society & Management Review. Available at https://doi.org/10.1177/22779752211061207, Available at SSRN: https://ssrn.com/abstract=3955445

Hrishikesh Desai (Contact Author)

Arkansas State University ( email )

BU 306, 2007 Aggie Road
College of Business, Arkansas State University
Jonesboro, AR State University 72467-0970
United States
8706808316 (Phone)

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