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Should companies report on risk in their annual reports?

This article delves into the importance of companies reporting on risks in their annual reports, exploring the evolution of risk disclosure, challenges faced, and the benefits it brings to investors and stakeholders. It emphasizes the need for detailed risk disclosure, including forward-looking information, actions taken to manage risks, and the overall risk position. The voluntary nature of risk disclosure and its benefits are discussed, along with examples from the UK and USA. Academic studies on risk communication are also referenced.

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Should companies report on risk in their annual reports?

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  1. Should companies report on risk in their annual reports? Professor Philip Linsley The University of York

  2. An introduction to the issue of risk disclosure • The development of the idea of risk disclosure • Problems in risk disclosure

  3. Risk & Business Every business involves risk BUT INVESTORS & STAKEHOLDERS HAVE LIMITED KNOWLEDGE OF THE RISKS

  4. SUGGESTED IN LATE 1990s OVERALL NEED FOR COHERENT VIEW OF RISK Companies should report on overall risk position 1. List the major risks 2. Describe actions taken to manage those risks 3. Identify the size of the risks

  5. FOOD AND CLOTHING COMPANY REVENUE £10bn Lists 11 major risks in 2016 annual report

  6. DIRECTORS IGNORED THE SUGGESTION IT WAS THEN SUGGESTED IN EARLY 2000s 1. Disclose forward-looking (future) risk information 2. But exclude commercially sensitive risk information 3. And disclose voluntarily (no regulation)

  7. Why future risk information? • Better than past risk information • But predicting the future is difficult • And predicting the future could be problematic • Inherent uncertainty and shareholder reliance on the information

  8. Why allow commercially sensitive information to be excluded? • To encourage directors • But this is problematic

  9. Why make risk disclosure voluntary? • Directors have incentives • Demonstrate accountability • Demonstrate equal treatment of all shareholders • Signal strategic capabilities • Lower cost of capital

  10. Risk disclosure requirements have now arisen in many different countries

  11. UK Law now requires description of principal risks and uncertainties in annual report But note that banks have very different requirements

  12. USA Item 1A of annual 10-K filing requires disclosure of risk factors

  13. ITEM 1A.  RISK FACTORS If we do not anticipate and address evolving consumer preferences, our business could suffer. Increased competition and capabilities in the marketplace could hurt our business.

  14. ITEM 1A.  RISK FACTORS Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, may reduce demand for our beverage products.

  15. ITEM 1A.  RISK FACTORS Raw materials supplies The citrus industry is subject to disease and the variability of weather conditions, which affect the supply of orange juice, an important raw material for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice. In addition, disease is reducing the number of trees and increasing costs. Adverse weather conditions may affect the supply of other agricultural products we use. For example, drought conditions in certain parts of the United States may negatively affect the supply of corn.

  16. Academic studies Beretta, S. and Bozzolan, S. (2004). A framework for the analysis of firm risk communication. The International Journal of Accounting, 39, 265-288. Maffei, M., Aria, M., Fiondella, C., Spanò, R., Zagaria, C. (2014). (Un)useful risk disclosure: explanations from the Italian banks. Managerial Auditing Journal, 29(7), 621 – 648.

  17. Does this mean risk disclosures are not useful? Perhaps they serve the purpose of reassurance?

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