How causal focus and specificity in risk factor disclosures Jointly affect investor judgments

Abstract

Firms’ risk factor disclosures reflect a specific state of uncertainty relating to their future negative outcomes. Theory suggests that investors’ perceived nature of knowable (versus random) uncertainty inherent in a risk event and their assessments of management credibility are key mechanisms underlying the effect of risk factor disclosures on investment willingness. Using a controlled experiment, I examine the joint effect of causal focus (the extent to which managers focus on causes versus consequences of risks) and specificity (specific references to names of objects and quantitative values) in risk factor disclosures on investor judgments. Results of my study show that when managers place a greater focus on causes of a risk, a higher level of specificity increases investment willingness due to enhanced feelings of knowable (as opposed to random) uncertainty in a risk and higher assessments of management credibility. In contrast, when managers have a greater focus on consequences of a risk, greater specificity lowers investment willingness due to diminished feelings of knowable uncertainty and lower credibility assessments. Overall, my results identify causal focus as an important attribute in risk factor disclosures and suggest that investors’ uncertainty perceptions and management credibility play an important role in mediating the effect of risk factor disclosures on investment judgments.