The Effect of Managers’ Risk Perceptions on Risk Factor Disclosures

Abstract

The SEC mandates that firms disclose material risk factors in their annual reports and adopts a principles-based approach, which allows managers to exercise discretion in determining which risks are material and the extent to which these risk factors are disclosed. To investigate whether risk factor disclosures reflect what managers consider to be material risks as the SEC intended, I examine manager-specific factors as a determinant of the content of risk factor disclosures. Specifically, I propose that managers have different risk perceptions that affect their assessment of material risks and ultimately the disclosure outcomes. Using a fixed effects approach, I find that individual managers have a significant effect on both the quantity and quality of risk factor disclosures after controlling for time varying firm characteristics, reporting incentives, firm fixed effects, and time fixed effects. Further, I examine managerial overconfidence, a managerial bias that is related to how managers perceive risks, and find that more overconfident managers disclose fewer risk factors and provide lower quality risk factor disclosures. Finally, I find that firms with more overconfident managers are more likely to receive a SEC comment letter on their risk factor disclosures. Overall, my findings suggest that manager-specific factors have a significant influence on the textual content of an important mandatory disclosure.