Journal of Asset Management and Financing (Sep 2022)
Analysis of Market Reaction to Risk Disclosure Factors
Abstract
Disclosure of information, especially information about company risks, provides investors with useful information about the inherent risks of the company. Whether this information signal has information content or not, it will lead to an increase in the investors' understanding and ultimately their reactions and changes in stock prices. Therefore, the aim of this study was to analyze the market reaction to risk disclosure factors, which included financial risk, operational risk, and strategic risk. To measure risk disclosure in this study, a method based on the content analysis of the board of directors' activity report to the general meeting of shareholders was used. Also, to investigate the market reaction, abnormal returns accumulated around the date of publication of the board of directors’ activity report were utilized. In the period of 2011-2019, among the companies listed on Tehran Stock Exchange (TSE), 655 years-companies were selected as a sample. Multiple regression was applied to test the research hypotheses. The results indicated that the total risk disclosure and types of risk disclosure, including financial risk, operational risk, and strategic risk, had a positive and significant effect on the abnormal returns on stock accumulation. In other words, the disclosure of risk factors had information content and the market reacted to their disclosure in the report of the board of directors.IntroductionDisclosure of information, especially information about company risks, provides useful information to investors about the company's inherent risks. If this information signal has information content, it will increase investors' understanding and they eventually react and the stock price changes. Therefore, in the purpose of the present study was to analyze market reaction to risk disclosure factors, which included financial risk, operational risk, and strategic risk. Method and DataTo measure risk disclosure, a method based on content analysis of the board of directors' activity report to general meeting of shareholders was used. To examine the market reaction, absolute value of cumulative abnormal return around the publication date of the board of directors' activity report was also utilized. In the period of 2011-2019, among the companies listed on Tehran Stock Exchange (TSE), 655 years-companies were selected as the sample. Multiple regression was also applied to test the research hypotheses. FindingsIn this study, the investors’ reaction to total risk disclosure and different categories of risk disclosure were investigated. Based on this, 4 hypotheses were formulated. The first hypothesis, which was about the effect of total risk disclosure by the company on the absolute value of cumulative abnormal return of the company in the period around the reporting date, was not rejected. The results of this hypothesis indicated that the investors responded to risk disclosure in financial reporting and as the rate of risk disclosure in the financial reporting increased, investors’ reactions increased. The second hypothesis on the effect of financial risk disclosure by the company on the absolute value of cumulative abnormal return in the period around the reporting date was not rejected. The results of this hypothesis test indicated that the higher the level of financial risk disclosure was in financial reporting, the higher the investors’ responses were. The third hypothesis on the effect of disclosure of non-financial operational risk by the company on the absolute value of cumulative abnormal return of the company in the period around the reporting date was not rejected. The results of this hypothesis test indicated that the higher the disclosure of non-financial operational risk was in financial reporting, the higher the investors’ responses were. The fourth hypothesis based on the effect of strategic risk disclosure by the company on the absolute value of cumulative abnormal return of the company in the period around the reporting date was not rejected. The results of this hypothesis test indicated that the higher the rate of strategic non-financial risk disclosure was in financial reporting, the higher the rate of the investors’ responses was. Conclusion and discussion Risk disclosure factors decrease investors’ information risk because when the company discloses the information related to its existing risks, the risk of adverse selection and information asymmetry are reduced. In fact, there is a kind of signal-giving condition about the company's performance and situation, which improves investors' understanding of the company's situation. Therefore, the higher the information content of risk disclosure information is, the more investors use this information in their economic decisions and take this information into account in the stock price.In general, the results of this study indicated a significant and direct effect between risk disclosure and its types with the absolute value of cumulative abnormal return. In other words, according to the theory of signaling in uncertainty conditions, receiving any information about the risks that the company faced could lead to reconsideration of investors' previous beliefs about the company's risks and the investors reactions, which affected risk disclosure. This indicated that in addition to the numerical information of financial statements, the disclosure of textual information about the risks faced by the company in the activity report of the board of directors had information content and the market in return became close to the publication of the board of directors’ report since they reacted to the disclosure of information related to the company risks.
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