communicating risk information: the issue of risk disclosure professor philip linsley the university...

Communicating risk information:

The issue of risk disclosure

Professor Philip Linsley

The University of York

Session outline

• PART 1:– An introduction to how risk ideas have

developed in recent years

• PART 2:– The development of the idea of risk disclosure

ideas

Developing risk ideas

1980s 1990s 2000s

Risk must be controlled

Then value at risk (VaR)

develops (banks)

We need to decide on the bank’s risk appetite

Enterprise wide risk

management

(ERM)

Risk has a positive side

Non-financial firms appoint risk officers

Risk becomes connected to governance

(and financial reporting)

And then the banking crisis

happens 2007 ….

The rise of a risk management industry

ConsultingProfessional

risk management organizations

Risk management standards AS/NZS 4360: 1995

AS/NZS 4360: 2004

AS/NZS ISO 31000: 2009

Remember also

…. This is just considering risk in a corporate

context

Risk has become an important issue in other

areas …

Some important approaches to risk

Approach Based upon work by:

Risk Society Beck

Cultural Theory Douglas

Governmentality Foucault

Psychometric Slovic

Accounting & Risk

Accounting

Internal to a company

External to a company

Financial accountant

Management accountant

Internal auditor External auditor Other advice

disclosure

Risk & business

RISK IS IMPORTANT IN BUSINESS

Volatile environment

Essence of business

Risk management developments

BUT

INVESTORS & OTHER STAKEHOLDERS HAVE LIMITED RISK KNOWLEDGE

Institute of Chartered Accountants in England & Wales (ICAEW)

Financial Reporting of Risk – Proposals for a Statement of Business Risk

(1998)

Accounts – complex – little on risk

Corporate Governance CodeONLY REQUIRED

Annual review of internal control systems to be reported to shareholders

ICAEW ARGUED:OVERALL NEED FOR COHERENT VIEW OF RISK

UK quoted companies should report on their overall risk position

1. Identify & prioritise risks

2. Describe actions taken to manage risk

3. Identify how risk can be measured

Subsequent ICAEW Proposals

No Surprises: The case for better risk reporting

(1999)

No Surprises: Working for better risk reporting

(2002)

But what are the problems in disclosing risk?

ONE PROBLEM

Would it be better to disclose past risk information or forward-looking (future) risk information?

But issues arise when you ask directors to disclose forward-looking (future) risk information

Inherently uncertain

Stakeholders relying on the information

Safe harbour provision

ANOTHER PROBLEM

What about commercially sensitive risk information?

But issues arise when you allow directors to exclude commercially sensitive risk information?

Omissions imply whole risk picture unknown

Some directors may declare all risk information is sensitive

‘Boilerplate’ arises

ANOTHER PROBLEM

Should you allow directors to voluntarily disclose risk information?

Why would directors disclose risk information voluntarily?

Benefits for stakeholders & companyEncourages better risk management

Cost of capital reduction

Why would directors disclose risk information voluntarily?

Agency theory Jensen & Meckling (1976)

Signalling theorySpence (1973)

TWO MORE PROBLEMS

Would it be better to disclose risk information that is quantified or not?

Is the annual report the best place to disclose risk?

Risk disclosure requirements in different countries

USA

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

• Obesity concerns may reduce demand for some of our products

• Adverse weather conditions could reduce the demand for some of our products

• Increased competition in the marketplace could hurt our business

• If we do not anticipate evolving consumer preferences our business could suffer

UK

Section 417 of the Companies Act 2006 requires description of principal

risks and uncertainties in annual report

Germany

Companies required to describe material risks and opportunities

NOTE

1.There have been a number of reports

addressing this issue directly and indirectly

2. Financial firm’s risk disclosures are much more

complex