The effects of risk factor disclosure on analysts’ earnings forecasts: evidence from Chinese IPOs

Abstract

ABSTRACT Using Chinese IPO firms, we examine the impact of risk information disclosure on the properties of financial analysts’ earnings forecasts. We construct a disclosure index by manually reading the disclosures of risk factors in IPO prospectuses. We find that high-quality risk factor disclosure is associated with lower earnings forecast bias, less dispersion, and more timely forecasts. Separating total risk factors into five different types, we show that analysts have better ability to process financial risk and operational risk disclosure compared to the other three types (technology-related risk, market risk, and macroeconomic risk). Cross-sectional tests reveal that the positive effect of risk disclosure is mainly concentrated in firms with greater information transparency (e.g., larger firms, firms with higher profitability, and firms with lower performance volatility). We further rule out other potential explanations (e.g., the effect of analyst sentiment) and conduct additional robustness tests. Our study has broad implications for firms in emerging economies.