You have been forewarned! The effects of risk management disclosures and disclosure tone on investors’ judgments

Abstract

We examine the effect of providing risk management disclosures alongside risk disclosures on investors' stock valuation judgments, and how risk disclosure tone influences this effect. In practice, risk management disclosures are mandated in some settings but not others although conceptually, disclosing both the risk and how it is managed offer investors the most holistic understanding of firm risk. We find that without risk materialization, risk management disclosures have a positive effect on judgments when the risk disclosure tone is positive. Also, investors provide lower (higher) stock valuations when a positive versus negative tone is used in the absence (presence) of risk management disclosures. However, with the negative news of risk materialization, risk management disclosures and tone no longer have an effect on investors’ judgments. Our findings have implications for managers and regulators, as investors may penalize firms that provide risk disclosures, even if these risks have been properly managed.