How the Spread of Risk Information Affects the Informativeness of Firms Textual Risk Disclosures

Companies in Europe and the US are required to explain the significant risk factors they face in their annual reports. Prior studies provide mixed evidence of the informativeness of such textual risk disclosures, suggesting that these disclosures are an amalgam of both boilerplate and informative risk factors. In this study, we differentiate between specific disclosed risk factors rather than considering the report as a whole. We find that the informativeness of disclosed risk factors depends on the extent to which new information is conveyed by each, which depends on the prior disclosures of that factor by the firm itself or by other firms in the same industry. We use a clustering-based topic modeling technique to categorize textual risk factors based on their semantic similarity and distinguish between new risk factors and those previously disclosed. We identify 3766 specific risk factor from 1,245,475 individual risk factor disclosures by 7559 US-listed firms from 2006 to 2021. We find that new risk factors added to a firm's annual report increase the investors' risk perception and uncertainty, measured by the stock return volatility and average bid-ask spread around the filing date, while reported risk factors that were already disclosed in previous year's annual report have a smaller effect on investors' uncertainty. Moreover, we find that in general, the informativeness of disclosed risk factors decreases the more the same risk factors are also disclosed by other firms in the same industry