A theory of risk disclosure

Mirko S. Heinle () and Kevin C. Smith ()
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Mirko S. Heinle: The University of Pennsylvania
Kevin C. Smith: The University of Pennsylvania

Review of Accounting Studies, 2017, vol. 22, issue 4, No 1, 1459-1491

Abstract: Abstract In this paper, we consider the price effects of risk disclosure. We develop a model in which investors are uncertain about the variance of a firm’s cash flows and the firm releases an imperfect signal regarding this variance. In our model, uncertainty over the riskiness of a firm’s cash flows leads to a variance uncertainty premium in its price. We demonstrate that risk disclosure decreases the firm’s cost of capital by reducing this premium and that the market response to risk disclosure is small when the expected level of risk is high. Moreover, we find that firms acquire and disclose more risk information when their cash flow risk is greater than expected. Finally, we demonstrate that in a multi-asset setting, only risk disclosure concerning systematic risks will impact the cost of capital.

Keywords: Risk disclosure; Variance uncertainty; Cost of capital (search for similar items in EconPapers)
JEL-codes: C11 D53 D83 G12 M41 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (26)

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DOI: 10.1007/s11142-017-9414-2

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