The impact of risk factor categorization and summary disclosures on investor risk perceptions

Abstract

In this study, I analyze the changes in investors’ risk assessments in response to the implementation of a recent SEC update that requires publicly listed companies to, within the risk factor section of their annual reports, separate their firm-specific risk factors from their general risk factors, as well as provide a summary of the risk factors. I also investigate the impact of adding more general risk factors to the general risk factor section, a possible action taken by management in order to dilute investors’ risk perceptions. I predict that categorizing risk factors by separating firm-specific risk factors from general risk factors increases risk perceptions, but that this effect is attenuated by the presence of a risk factor summary. Results support this latter prediction when a bulleted summary is examined. However, when a numbered summary is examined, separating firm-specific risks from general risks increases risk perception regardless of whether a numbered summary is provided. I also predict that adding more general risks may either increase risk perceptions or reduce them. Results show that adding extra general risks do not affect risk perceptions. However, when manipulation check failures are removed from the sample, I do find that, while adding extra risk factors does not affect risk perception when a summary is absent, it does reduce risk perception when a summary is present. Supplementary analyses show that higher company risk perceptions translate into higher assessments of future material loss likelihood. Finally, in supplementary tests, the study discredits a competing theory by eliminating risk factor readability as a possible driver of the results.