Risk Fact or Fiction: The information content of risk factor disclosures

By Maclean Gaulin (job market paper)
Date: 2016-11-15

Using risk factors as the unit of disclosure, I show that the managerial decision to add new, retain existing, and remove obsolete risk factors predicts future adverse reporting and real outcomes, providing novel evidence that managers are removing stale disclosures on a timely basis. After controlling for firm-specific heterogeneity, I find that the count of individual risk factors disclosed, rather than an aggregate word count, explains time-series variation in managerial disclosure decisions, consistent with the regulatory intent. I also examine the effect on the disclosure equilibrium by studying managerial response to demand shocks from public and private enforcement actions. The results show that firms respond to investor demand in a manner consistent with the litigation shield hypothesis, and that this effect persists for multiple years. Consistent with the regulatory cost-benefit function, public enforcement does not result in a net increase in disclosed risk factors, but does evoke more definitive disclosures with language that is more specific and an increased use of numbers. Finally, I find that managers provide additional risk factors prior to securities litigation, especially when they are subsequently settled, consistent with supply-side litigation shield effects.