Risk disclosure and firm risk: Evidence from Canadian firms

Michel Coulmont,Caroline Talbot,Sylvie Berthelot

doi:10.22495/rgcv10i1p4

Michel Coulmont, Caroline Talbot + Show 1 more

Open Access

https://doi.org/10.22495/rgcv10i1p4

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Abstract

In recent decades, financial and accounting regulators have turned the spotlight on risk management and disclosure. Like securities regulators in the United States, the United Kingdom and several other countries, Canadian Securities Administrators have set out requirements for the disclosure and discussion of risks in the MD&A section of annual reports. Responding positively to these new guidelines, organisations now report many risks in their MD&A. These disclosure requirements are intended to provide information about a company’s material risks to help stakeholders understand and evaluate interrelated risks, the risks’ impact and the company’s risk management strategies (Khandelwal, Kumar, Verma, & Pratap Singh, 2019). However, since the nature of the risks disclosed derives wholly from organisational decisions, the content of these disclosures can be considered voluntary. For this reason, some critics argue that risk disclosures are by and large boilerplate in nature (Bao & Datta, 2014; Hope, Hu, & Lu, 2016). From this perspective, this study aims to examine whether there is a relationship between the risks firms disclose in their annual reports and their systematic risk. The regression analyses were carried out on the risks disclosed by a sample of 200 Canadian companies included in the 2016 Toronto Stock Exchange S&P/TSX Composite Index. These analyses revealed a positive and significant relationship between the risks disclosed and the firms’ systematic risk. Our results support the regulatory approaches respecting this type of information adopted by a number of countries. Accordingly, disclosing the risks that companies face should help small investors understand and appreciate them.

Highlights

Since the financial scandals in the early 2000s, interest in risk disclosure in financial reports has significantly increased
The model used to examine the link between a firm’s risk disclosure and its risk as perceived by shareholders is as follows: BETAi = β0 + β1RISKi + β2SIZEi + β3POUTi + β4LIQUi + β5DEBTi + β6GROWi + β7ROEi + (2) β8−12INDi + εi where, between the systematic risk (BETA) is the firm’s systematic risk; RISK is i i the number of risks disclosed by the company in its annual report; SIZE is the total assets of the firm; i
In the words of the Canadian Performance Reporting Board (CPRB) report (2008), “risk disclosures are seen by investors as an important element of Management Discussion and Analysis (MD&A)” (p. 11)

Summary

Introduction

Since the financial scandals in the early 2000s, interest in risk disclosure in financial reports has significantly increased. In Canada, the Canadian Securities Administrators, including the Ontario Securities Commission (OSC, 2003), followed suit in 2003, adopting National Instrument 51-102 on continuous disclosure obligations requiring public companies to disclose information on risks that can materially affect their future performance in their Management Discussion and Analysis (MD&A). In mandating this disclosure for all firms, the OCS suggests that risk factor disclosures are useful and informative and that investors benefit from this information, as concluded by Rajgopal (1999) and Linsmeier, Thornton, Venkatachalam, and Welker (2002). The object of these guidelines is to assist senior management and board members in preparing and presenting a management report that will ensure that present and future investors, individual investors, receive the necessary and pertinent information to make investment decisions (CPRB, 2004)

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