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Articles

The Effect of Business Strategy on Risk Disclosure

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ABSTRACT

For a sample of nonfinancial and non-utility firms from the European Economic Area in 2005–2017, we find that a firm’s business strategy is a determinant of the amount of risk factor information in the annual report. Firms with an innovation-oriented prospector strategy report more about their risk factors than firms with an efficiency-oriented defender strategy. This is because, first, these innovation-oriented prospectors face greater risks and uncertainties and the regulator and enforcement institution expect them to report these accordingly in the annual report. Second, given the discretion the firms have in disclosing risks, prospectors are more likely to engage in voluntary disclosure. It seems that the benefits outweigh the costs of revealing proprietary information. Further, our findings reveal that business strategy influences the coverage of the main risk topics and risk disclosure complexity. Additionally, the influence of business strategy on risk disclosure is stronger for small, young, and low-technology firms.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 Directive 2013/34/EU was amended by Directive 2014/95/EU.

2 This is in sharp contrast to the availability of U.S. companies’ annual reports. The U.S. Security and Exchange Commission (SEC) requires firms to file annual reports with a specific form, 10-K. The SEC makes these 10-K forms available to the public through its Electronic Data Gathering, Analysis, and Retrieval system, its search platform. It is therefore comparably easy to access and download large numbers of annual reports for the U.S. context.

3 We include all 28 EU member states and two countries, namely, Iceland and Norway, of the European Free Trade Association. Lichtenstein is not included in the final sample owing to data unavailability.

4 The word list developed by Elshandidy et al. (Citation2013) contains the following terms, where an asterisk denotes word derivatives: risk*, loss*, decline (declined), decrease (decreased), less, low*, fail (failure), threat, verse (versed; reverse; reversed), viable, against, catastrophe (catastrophic), shortage, unable, challenge (challenges), uncertain (uncertainty; uncertainties), gain (gains), chance (chances), increase (increased), peak (peaked), fluctuate*, differ*, diversify*, probable*, and significant*.

5 Consistent with Bentley et al. (Citation2013), we use two-digit Standard Industrial Classification (SIC) codes for industry classification.

6 A score of five is given if the firm–year observation is within the fifth quintile, and a score of one is given if the firm–year observation is within the first quintile, except for capital intensity. Capital intensity is reverse scored.

7 Appendix A provides more details on all the variables, including the control variables, in our regression analysis.

8 Appendix B shows the mean values of RiskDisclosure and BusinessStrategy by country.

9 We describe how we calculate the number of risk-related sentences in the annual report in Section 3.1.

10 As an example, in its 2013 annual report, Flughafen Wien AG uses 145 systematic, 151 idiosyncratic, 30 financial, 35 tax, and 27 legal words in its risk-related sentences. Thus, the Herfindahl index is 0.31 and the value of Risk topic coverage is 0.645.

11 We use Francis and Schipper’s (Citation1999) definition of high- and low-technology industries based on three-digit SIC codes.