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Corporate risk disclosure: its determinants and its impact on the company's cost of equity capital

Rajab, Bassam


Bassam Rajab


Risk disclosure has received considerable interest and attention in recent times. The aim of this research is to examine risk information disclosure in annual reports with the aim of establishing trends. Further, this research empirically examines the influence of four firm factors on the level of risk disclosure in the annual reports. These factors are firm size, leverage, industry and US-dual listing. In addition, the research examines the association between risk disclosure and the company's cost of equity capital (and information asymmetry) after controlling for firm size and market beta.
The annual reports of a sample comprising 52 UK non-financial companies, drawn from the FTSE-100 index, for three different periods (1998,2001, and 2004) were sought, collected, and analysed. Content analysis was applied and risk disclosure in the annual report was measured according to the number of sentences disclosed and trends were analysed over the six-year period. Risk disclosure sentences were classified according to four main quality dimensions: type of risk, the nature of the evidence, the type of news disclosed, and news time-frame. A four-stage dividend growth model was used to measure the company's cost of equity capital. Bid-ask spread and stock volatility were also used as proxies for information asymmetry.
Only when investors perceive that the information is relevant, risk information disclosed in the annual report can lead to a reduction in the cost of equity capital. The study found, in aggregate, a trend of increasing amounts of risk disclosure in the annual report. Risk disclosure was found primarily qualitative; good and neutral; and non-time. There is minimal disclosure of quantified risk information and bad news information. These results suggest that accounting rules and regulations, in addition to recommendations from accounting institutions, have influenced the increase in the level of risk information disclosed, though without ensuring the quality of the disclosed risk information. US-dual listing and industry are found to be significantly related to risk disclosure, but firm size and leverage are found to have insignificant association with the level of risk disclosure. These findings suggest that the extent of annual report risk disclosure is driven more by regulation than by the market.
The findings reveal that for the largest UK companies with high analyst following, no relation was found between risk disclosure level and cost of equity capital. However, the study found that both quantitative and bad news risk information are significantly and negatively related to stock volatility. Moreover, a significant and negative association was found between bad news risk disclosure and bid-ask spread. This suggests that firms with greater bad news and quantitative disclosure enjoy a reduction in information asymmetry as measured by proxies for information asymmetry. Overall, the analysis suggests that UK companies make substantial risk disclosure but the usefulness of this disclosure is limited.

Thesis Type Thesis
Deposit Date May 5, 2010
Peer Reviewed Not Peer Reviewed
Keywords risk analysis; information disclosure; equity capital; trends; information asymmetry;
Public URL
Contract Date May 5, 2010
Award Date 2009-02


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