Does competitive position of a firm affect the quality of risk disclosure?

Abstract

This paper investigates the impact of competitive position of the firm on the quality of risk disclosures in annual report. We develop a composite measure as a proxy for quality of disclosures by factoring in both the quantity of disclosure and the semantic attributes, namely, nature, time-orientation and tone of disclosure. In the backdrop of a unique natural setting that Indian regulatory environment offers, we use a sample of more than 4000 annual reports covering a 10-year period from 2005 to 2015 and employ a system-GMM regression to address the problem of endogeneity to find that firms that have an advantageous competitive position provide more comprehensive disclosures. In sharp contrast to the tenets of proprietary cost hypothesis that due to associated disclosure costs firms lose their competitive advantage and hence shy away from disclosure, we find that companies that fare well in product markets signal their strengths through enhanced disclosure to maintain their legitimacy and stakeholders' confidence. Further analysis reveals that firms with sound industry position tend to be transparent on a higher number of risk items. This study makes a unique contribution to the literature by examining an unexplored strategic dimension- firm's competitive position- as a deterrent or inducement to risk disclosure. Accordingly, the results have policy implications for various jurisdictions that do not have mandatory disclosure norms and even for those that follow the ‘comply or explain’ approach.