Management Risk Reporting Practices and their determinants

Abstract

In recent years, the need for effective risk management, internal control and transparent risk reporting has become an important corporate governance principle and a predominant issue in business. Already in 1987, the AICPA[ ] report stated that shareholders are increasingly demanding that financial statements include more information concerning the risks and uncertainties companies are facing (Schrand and Elliott, 1998). Abraham and Cox (2007) claim that this information can help investors to determine the risk profile of a company and estimate its market value. Risk disclosure can be beneficial for several reasons. It mitigates information asymmetry between management and external shareholders and can have positive effects on the trust and confidence stakeholders have in the firm’s management. It may decrease the firm’s perceived risk because an open disclosure strategy supposedly results in a better assessment of the firm’s future performance. This, in turn, can lead to a decline in the firms cost of capital (Linsley and Shrives, 2006a; Abraham and Cox, 2007; ICAEW[ ], 1999a) and to a reduced possibility of financial failure (Beretta and Bozzolan, 2004; Solomon et al., 2000). The Turnbull Guidance in the UK (ICAEW, 1999b) and the Jenkins Committee Report in the US (AICPA, 1994) have accelerated the debate on the quality and effectiveness of risk reporting. Boards and investors indicate that the Turnbull Guidance has led to a marked improvement in the overall standard of risk management since 1999 (FRC[ ], 2005). In response to the developments in the US and UK, a number of authorities worldwide have reconsidered the set of requirements for disclosure of relevant and understandable forward-looking information about risk. As a result, narrative risk factor disclosure is nowadays increasingly required in periodic reports, both annual and quarterly. Despite the growing interest in risk issues, only few articles have studied the characteristics of risk disclosing firms. The question which firm and governance characteristics facilitate management risk reporting has largely been ignored in the literature. Consequently, several authors encourage filling the gap in the literature with respect to empirical risk reporting research (Linsley and Shrives, 2000, 2006a, 2006b; Beretta and Bozzolan, 2004; Solomon et al., 2000; ICAEW, 1999a; Schrand and Elliott, 1998). The aim of this study is to identify the firm and governance characteristics that appear to facilitate risk disclosure by management, using a sample of large and medium-sized Belgian listed firms. The next paragraph discusses the issue of risk disclosure. Hypotheses are formulated in paragraph three and paragraph four presents the data and the empirical results. Paragraph five concludes.