۱- Introduction

۲- Literature review and hypothesis development

۳- Empirical approach

۴- Empirical results

۵- Robustness check

۶- Conclusion

References

Abstract

We take advantage of the introduction phase of business risk disclosure in Japan as a natural experiment to examine the causal effects of the disclosure on firm risk. In contrast to risk factor disclosure that appeared partly in the Management Discussion and Analysis section (MD&A) in the United States, Japanese business risk disclosure is a new, independent disclosure regime, which began in the fiscal year ending March 2004.We find that the introduction of mandatory business risk disclosure has a negative impact on total risk. This suggests that an increase in business risk disclosure contributes to reduce a firm’s cost of capital, which is contrary to the results found in previous research. However, we also find that there is a positive relationship across firms and years after the inception between the amount of business risk disclosure and total risk, indicating that mandatory business risk disclosure has an impact on increasing investors’ assessment of firm risk. Although the two effects offset each other, the effects of enhanced disclosure of business risks on reducing the cost of capital exceed the effects on increasing investors’ assessment of firm risk.

Introduction

We empirically examine the economic effects of textual disclosure focusing on mandatory business risk disclosure. We focus on the introduction phase of business risk disclosure in Japan to capture the exogenous variation in the supply of public information to identify whether mandatory business risk disclosure increases or decreases investors’ assessment of firm risk. Business risk disclosure in Japan is intended to enable investors to assess a firm’s business risk (FSA, 2003), and it is equivalent to the risk factors disclosure included in the 10-K filings in the United States. However, it is noteworthy that business risks appeared partly in the Management Discussion and Analysis section (MD&A) in the United States before the introduction of risk factors disclosures (e.g., comments letter 9 on proposed rules, SEC 1999). In contrast, Japanese business risk disclosure is a new, independent disclosure regime, which began in the fiscal year ending March 2004. Thus, we take advantage of the introduction of business risk disclosure in Japan as a natural experiment to examine the causal effects of mandatory business risk disclosure on firm risk. There is an additional benefit from focusing on the new business risk disclosure rule in Japan. Because there was little information about the content, format, and writing style accompanying the introduction of the new regulations, it would seem unreasonable to expect that managers would only disclose boilerplate information or industry-wide or macroeconomic risk factors in their mandatory business risk disclosure, at least initially. In this sense, we would expect more accurate experiment about the effects of business risk disclosures by focusing on the introduction phase in Japan.