Essays on Risk Factor Disclosures

This dissertation consists of two empirical essays on risk factor disclosures. The first essay examines language complexity, a much discussed aspect of these disclosures. Risk factor disclosures were mandated as a discussion of risks faced by the firm. However, industry has criticized them as being unclear and uninformative. A major reason cited for this is firms’ defensive approach to risk factor disclosures, which involves discussing all possible risks to shield themselves from potential shareholder lawsuits. Using Liberal court, an exogenous measure of litigation risk, I examine the direct impact of litigation risk on the complexity of risk factor disclosures. I predict and find that, when firms anticipate a higher risk of shareholder litigation, their risk factor disclosure language shows more complexity, an effect which is stronger for bad news firms. In further tests, I find that risk factor disclosure complexity is associated with greater information asymmetry. Overall, my results are consistent with the argument that firms use risk factor disclosures to seek safe harbor from litigation and in the process, make the language complex and less informative. The second essay examines the role of management in drafting of risk factor disclosures. While risk factor disclosures have invited academic debate about their informativeness, there is little evidence on how management influences them. Practitioners note that these disclosures are primarily driven by legal teams. In this paper, I use CEO changes to provide evidence on whether managers influence risk factor disclosures. I find that in the years when a new CEO is appointed, there are changes in risk factor disclosures, and the negative and uncertain tone in these disclosures increases. These effects are more pronounced for firms with higher CEO share ownership but no different for firms with higher litigation risk. This suggests that my main results are not driven by the firm’s concerns on the appointment of the CEO, but the concerns of the new CEOs themselves. I also find that the risk factor disclosure changes around CEO changes are not informative to the market. My results suggest that there is management participation in risk factor disclosures, but this participation does not necessarily translate into higher informativeness.