Examining the Association between User-Based Risk Disclosure Quality, Cost of Capital, and Market Reaction

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Abstract

Risk divulgence has received particular regulatory attention after downturns of large companies and
volatilities in global capital markets. In January 1997, the Security and Exchange Commission (SEC)
issued the Financial Reporting Release No.48 (FRR No.48) to guide how listed firms disclose suitable
information about their Financial Instruments’ market risk. The Canadian Institute of Chartered
Accountants (CICA, 2004) has issued a report regarding “Management’s Discussion & Analysis -
Guidance on Preparation and Disclosure”. This report recommends that a firm should “disclose its
principal risks and describe related risk management systems to enable MD&A report readers to
understand and evaluate the firm’s risks and its decisions regarding the management of such risks”. In the
same vein, The Institute of Chartered Accountant in England and Wales (ICAEW, 2011) has pointed out
that investors need information about risk to perform their own risk assessments and take a business’s
risks into account, so far as they aware of them, in considering whether and on what terms to invest in it.
Linsley and Shrives (2006) have defined risk disclosure as “if the reader is informed of any opportunity
or prospect or of any hazard, danger, harm, threat, or exposure, which has already impacted upon the
company or may impact upon the company in the future or of the management of any such opportunity
prospect, hazard, harm, threat or exposure”. While, Miihkinen (2012) define it, as “information that
describes firm’s major risks and their economic impact on future performance”. These definitions implies
the relevance value of risk information and its predictive power in investment decision making.
Prior studies relied on several disclosure theories to explain different avenues and investigate the impact
of risk disclosure on decision-making usefulness in different countries.

Author

• Yousra Rageh Abdulrahman Obiedallah, University of Toledo