How Informative is Risk Reporting? - a Review of Disclosure Models

Abstract

Risk reporting is an emerging reporting challenge in Europe. Current literature assumes corporate risk reporting to be informative for its users. The purpose of this paper is to investigate in how far risk disclosures can meet the information function alleged. Embedded in frameworks of economics of information and of risk management, a substantial review and discussion of discretionary disclosure models, including cheap talk-models, provides a sound basis for assessing the information value provided by risk reports. The results are manifold. First, the review highlights strong incentives for discretion and manipulation by the manager who can use the report as a measure of handling derivative risks. These margins particularly stem from the uncertainty of availability and the non-verifiability of risk information. Second, the review exposes regulative implications to assist the information function of risk reporting. Those include the need for comparable reporting repelling a pure management approach, and for supplemental information on corporate risk management. Third, the discussion qualifies common arguments concerning risk reporting. E.g., the ex post nominal/actual value comparison is inappropriate to assess credibility, the fear of self-fulfilling prophecies does not reason opt-out clauses. However, the alerting main result of the paper is that, even in a regulated accounting environment, the information value of risk reports must not be overestimated.