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International Review of Financial Analysis xxx (2013) xxxxxx

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International Review of Financial Analysis

Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK


FTSE all-share companies
Tamer Elshandidy a,, Ian Fraser b, Khaled Hussainey c,d
a
University of Bristol, United Kingdom
b
University of Stirling, United Kingdom
c
University of Plymouth, United Kingdom
d
Ain Shams University, Egypt

a r t i c l e i n f o a b s t r a c t

Available online xxxx This paper investigates the impact of corporate risk levels on aggregated, voluntary and mandatory risk disclo-
sures in the annual report narratives of UK non-nancial listed companies. We nd that rms characterised by
JEL classication: higher levels of systematic, nancing risks and risk-adjusted returns and those with lower levels of stock return
G32 variability are likely to exhibit signicantly higher levels of aggregated and voluntary risk disclosures. The results
M41
also show that rms of large size, high dividend-yield, high board independence, low (high) insider (outsider)
M48
ownership, and effective audit environments are likely to exhibit higher levels of aggregated and voluntary
Keywords: risk disclosures than other rms. Similarly, mandatory risk disclosures are inuenced positively by rm size,
Aggregated dividend-yield and board independence and negatively by high leverage. The results suggest that managers of
Voluntary rms exhibiting greater compliance with mandatory regulations have a greater propensity to make voluntary
Mandatory risk disclosures risk disclosures. When we distinguish between high- and low-risk rms, we nd that high-risk rms appear
Automated content analysis to be more sensitive to underlying risk levels, resulting in more disclosure of both voluntary and mandatory
LMM risk information than in the case of low-risk rms. The results generally support the present UK emphasis on en-
High- and low-risk rms couraging rather than mandating risk disclosure. Nevertheless, under this regime, the voluntary risk disclosures
of some rms, e.g., those characterised by higher-volatility market returns, do not reect their underlying risk
levels.
2013 Elsevier Inc. All rights reserved.

1. Introduction aggregated risk disclosures and total risk as a control variable, although
not as a main driver.
Despite an extensive prior literature, there is little research on how This paper investigates how rm risk levels impact aggregated,
risk levels inuence rms in providing risk disclosures in corporate an- voluntary and mandatory risk disclosures, as distinct from general
nual reports. Linsley and Shrives (2000, 2005, 2006) nd that aggregat- disclosure studies (Ahmed & Courtis, 1999; Chavent, Ding, Stolowy,
ed risk disclosures are associated more with rm size than with risk & Wang, 2006; Firth, 1984; Lang & Lundholm, 1993; Meek, Roberts,
levels. Abraham and Cox (2007) identify a positive association between & Gray, 1995), which are mainly concerned with discussing the im-
pact of risk as a control variable only on voluntary disclosures. The
ndings have implications for regulators by contributing to knowl-
edge on the effectiveness of the extant UK nancial reporting regime.
This paper has beneted from the comments and suggestions of participants at the
Information asymmetry underpins theories of risk disclosures.
4th European Risk Conference (Nottingham University, 2010), the British Accounting Regulatory theory (e.g., Dobler, 2008; Leftwich, 1980; Ogus, 2001) pro-
Association Conference (Cardiff University, 2010) and the ICAS Research Workshop vides a conceptual basis for the mandatory disclosures necessary to
(Edinburgh, 2010). We are also grateful to participants at the 13th Scottish Doctoral compensate for market failure. Incentive theories for voluntary risk dis-
Colloquium (University of Stirling, 2009) for their useful comments and suggestions
closures include agency theory (e.g., Abraham & Cox, 2007; Jensen &
on an earlier draft of the paper. We would like to thank George Iatridis (Special Issue
Managing Guest Editor), and two anonymous referees for their useful comments and Meckling, 1976) and signalling theory (e.g., Akerlof, 1970; Spence,
suggestions. We thank Matt Bamber, Sheila Ellwood, Mike Jones, Neslihan Ozkan, and 1973; Watson, Shrives, & Marston, 2002).
Ioannis Tsalavoutas for their helpful comments. Elshandidy gratefully acknowledges Based on the Capital Asset Pricing Model (CAPM), theoretical studies
the nancial support of the Egyptian Government and the University of Helwan in (e.g., Bowman, 1979; Chiou & Su, 2007; Hamada, 1972) explain the as-
funding his PhD degree at the University of Stirling.
Corresponding author at: School of Economics, Finance and Management, University
sociation of market-risk measures (namely, market beta) with leverage,
of Bristol, 8 Woodland Road, Clifton, Bristol BS8 1TN, United Kingdom. accounting beta, earning variability, size, dividend-yield and rm
E-mail address: Tamer.Elashandidy@bristol.ac.uk (T. Elshandidy). growth. Prior empirical research has investigated the extent to which

1057-5219/$ see front matter 2013 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.irfa.2013.07.010

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
2 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

accounting-risk measures can serve as surrogates for market-risk mea- residual dependency problem frequently neglected in market-based
sures (e.g., Beaver, Kettler, & Scholes, 1970; Brimble & Hodgson, 2007; accounting research (Bernard, 1987; Gow, Ormazabal, & Taylor,
Giner & Revert, 2006; Lev & Kunitzky, 1974; Papadamou & Tzivinikos, 2010).
2012). This paper employs four market-risk measures (volatility of mar- The paper proceeds as follows: The next section discusses relevant
ket returns, beta, volatility of the standard error of the CAPM and the UK regulations and professional initiatives. Section 3 draws on dis-
Sharpe ratio) and two accounting-risk measures (leverage and current closure theories and literature to formulate the research hypotheses.
ratio) to capture six risk categories (total, systematic, unsystematic, Measurement of aggregated, voluntary and mandatory risk disclo-
risk-adjusted returns, nancing and liquidity risks, respectively) repre- sures is discussed in Section 4. Section 5 explains the research
sentative of overall rm risk levels. methods. Section 6 discusses the results. Section 7 introduces further
This paper builds on existing work analysing annual report analyses, including a comparison of high- and low-risk rms and ro-
narratives using automated content analysis (e.g., Gruning, 2011; bustness checks. Section 8 concludes, discusses the limitations and sug-
Hussainey, Schleicher, & Walker, 2003; Kothari, Li, & Short, 2009; gests areas for future research.
Muslu, Radhakrishnan, Subramanyam, & Lim, 2011). Nudist 6 is
used to analyse the report narratives.1
We nd that systematic and nancing risks, risk-adjusted returns,
rm size, dividend-yield, board size, proportion of non-executive direc- 2. UK risk reporting: standards and professional initiatives
tors, proportion of independent non-executive directors, low (high)
insider (outsider) ownership and effective audit environment affect Regulations and professional initiatives on risk reporting are funda-
both aggregated and voluntary risk disclosures positively, while total mental to distinguishing between voluntary and mandatory risk dis-
risk does so negatively. These results suggest that after controlling for closures. As neither the UK Accounting Standards Board (ASB) nor the
other rm characteristics and corporate governance mechanisms, UK International Accounting Standards Board3 (IASB) has issued a com-
non-nancial rms' provision of voluntary risk-related information re- prehensive mandatory risk reporting standard, the non-mandatory
ects most underlying corporate risks. Mandatory risk disclosures are publications of the Institute of Chartered Accountants in England and
inuenced positively (negatively) by rm size, dividend-yield, board Wales (ICAEW, 1997, 1999, 2002a, 2002b, 2011) assume particular
size, the proportion of non-executive directors and the proportion of in- interest.
dependent non-executive directors (nancing risk). These results for The ICAEW (1997) discusses risk disclosures in corporate annual
mandatory disclosure suggest that UK non-nancial rms' compliance reports, emphasising gains and losses in dening risk, the distinction
with risk regulations reects corporate governance mechanisms and between nancial and non-nancial risks, commercial sensitivity in
other rm characteristics rather than underlying risk levels. moderating the disclosure of certain risks and the use of both account-
Our ndings have implications for theory and practice. First, the ing and non-accounting data to quantify risk. The ICAEW (1999) high-
factors inuencing aggregated and voluntary risk disclosures differ lights the minimisation of cost of capital as an incentive for voluntary
from those inuencing mandatory risk disclosures. Second, our re- disclosure. The ICAEW (2002a) summarises previous publications; the
sults support the UK emphasis on encouraging risk disclosure2 rather ICAEW (2002b) deals with risk disclosures for small entities.
than imposing extensive mandatory requirements. The ICAEW (2011) identies challenges in disclosing risk informa-
This paper makes a major contribution to the literature on risk tion in annual report narratives (doubts regarding the accuracy of the
disclosure. It identies the extent to which rm risk levels impact ag- reporting in quantitative or qualitative risk disclosures, higher compet-
gregated, voluntary and mandatory risk disclosures, rather than cor- itive costs for rms that disclose risk information relative to those that
porate disclosures generally, as does previous research. Exploring do not, and difculties outlining all risks that rms face). Furthermore,
the incentives for not only aggregated (e.g., Abraham & Cox, 2007; ICAEW (2011) suggests several ways in which risk reporting in annual
Linsley & Shrives, 2006) but also voluntary and mandatory risk disclo- reports can be improved (e.g., continuously considering investors'
sures, allows identication of the drivers motivating each disclosure needs and prioritising quantitative above qualitative risk). The ASB
category. Investigating the relationship between risk disclosure levels Statement of Principles (ASB, 1999) emphasises the importance of risk
and risk levels helps clarify the effectiveness of the UK approach to risk information for decision-making (e.g., assessing the ability to generate
disclosures with its voluntary emphasis. We control for other rm future cash ows, the extent to which rms are at-risk and identifying
characteristics, including rm size, protability, growth and dividend- the effect on investors of variability in expected returns).
yield, and corporate governance mechanisms, including board charac- Six principal themes relating to risk disclosures are addressed by UK
teristics, ownership structure and audit environment. While prior risk GAAP and International Accounting Standards: contingencies (FRS 12;
research provides some (mixed) evidence on rm size and board char- IAS 37), segment reporting (SSAP 25; IAS 14 and IFRS 8), foreign ex-
acteristics, the other control variables have not yet been examined. change transactions (FRS 23; IAS 21), substance of transactions or in-
The paper makes a secondary contribution in terms of the research vestments (FRS 5; IAS 16), related-party disclosures (FRS 8; IAS 24)
deign. We text-searched a large-scale sample of annual reports over a and derivatives (FRS 13, 25, 26, 29; IAS 32, 39, and IFRS 7). The rst
four-year period to identify risk disclosure incentives more robustly ve themes require the provision of information about potential gains
than previous research, and we use a Linear Mixed Model (LMM) to and losses; the last (derivatives) requires disclosures relating to curren-
mitigate problems caused by cross-sectional (heteroskedasticity) cy, liquidity, fair value, nancial assets and liability hedging, market
and/or time series data (auto-correlation). LMM accounts for the price, commodity contracts and qualitative and quantitative market
risk disclosures. We use the above regulatory and professional literature
as a basis for identifying mandatory disclosures and distinguishing be-
tween these and voluntary disclosures.
1
NVivo 8 is an upgrade of Nudist 6 and has certain distinct advantages. NVivo 8 is
easy to use, incorporating tools to visualise text and outputs. The command le in Nud- 3. Hypothesis development: theories and prior research
ist 6, however, allows exibility in importing raw data in a specic order to facilitate
merging rms' disclosure scores with their market data. More importantly, while Nudist
6 permits many choices of code unit, including sentence, line, and paragraph, NVivo per-
Our hypotheses are grounded in disclosure theory and prior research.
mits only the word as the unit of coding. The problem of double counting of frequent words
is difcult to avoid with NVivo, and less likely with Nudist. We therefore use Nudist 6.
2 3
An example is the risk recommendations of the Institute of Chartered Accountants UK-listed companies have been required to adopt the International Financial
of England and Wales (ICAEW, 1997, 1999, 2002a, 2002b, 2011). Reporting Standards (IFRS) since 2005.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 3

3.1. Theories of mandatory and voluntary risk disclosures on nancial reporting (Hodder & McAnally, 2001; Jorgensen &
Kirschenheiter, 2003, 2012; Jorion, 2002; Linsmeier, Thornton,
The objective of mitigating information asymmetry underpins Venkatachalam, & Welker, 2002; Rajgopal, 1999).6 The second concen-
theories of mandatory and voluntary risk disclosures.4 trates on the determinants of risk disclosure. Most European risk dis-
closure studies (e.g., Beretta & Bozzolan, 2004; Deumes & Knechel,
3.1.1. Regulatory theory 2008; Vandemaele et al., 2009) and UK studies in particular (e.g.,
Imperfect markets arguably require some degree of mandatory Abraham & Cox, 2007; Linsley & Shrives, 2005, 2006) are of this na-
disclosure to protect investors and mitigate information asymmetry ture. This literature nds that rm size (Linsley & Shrives, 2005,
(e.g., Cooper & Keim, 1983; Fields, Lys, & Vincent, 2001; Healy & 2006) and corporate governance (Abraham & Cox, 2007;
Palepu, 2001; Leftwich, 1980; Ogus, 2001). The threat of economic Vandemaele et al., 2009) signicantly impact risk disclosures.
disadvantage may give rise to disincentives to disclose risk informa-
tion voluntarily (Dobler, 2008). Some UK risk research (Abraham &
Cox, 2007; Marshall & Weetman, 2002) has found that regulation af- 3.3. Hypothesis development
fects voluntary risk disclosure levels positively.
The research design captures the extent to which risk levels moti-
vate rms to disclose voluntary and/or mandatory risk information in
3.1.2. Managers' incentive theories
their annual reports.
Core (2001) and Beyer, Cohen, Lys, and Walther (2010) argue for
further research on the association between voluntary disclosure and
managerial incentives conceptualised by agency and signalling theo- 3.3.1. Market-risk measures and risk disclosure
ries. Agency theory (Jensen & Meckling, 1976) is used to explain vol- The relationship between risk and general disclosure levels has been
untary disclosure by rms (e.g., Abraham & Cox, 2007; Vandemaele, studied extensively (e.g., Alexander, 1996; Firth, 1984; Hassan, Romilly,
Vergauwen, & Michels, 2009) to owners. Managers may provide risk Giorgioni, & Power, 2009; Hussainey & Al-Najjar, 2011; Kothari et al.,
information to reduce agency costs, resulting in reduced information 2009; Lang & Lundholm, 1993; Lev & Penman, 1990) and has produced
asymmetry. mixed results.
Information asymmetry also underpins signalling theory, original- Lang and Lundholm (1993) argue that performance variability af-
ly proposed by Akerlof (1970), developed by Spence (1973) and ap- fects disclosure levels negatively, identifying such an association be-
plied in some prior general disclosure research (e.g., Aboody & Lev, tween the volatility of market returns and general disclosure levels.
2000; Lev & Penman, 1990; Watson et al., 2002), which rationalises Alexander (1996), however, argues that rms with more volatile earn-
wider voluntary reporting to the capital markets. Managers may sig- ings are likely to provide comparatively greater disclosure in their an-
nal their quality and ability in identifying, measuring and managing nual reports. Lev and Penman (1990) nd no signicant relationship
risk, thus distinguishing themselves from other managers who may between disclosure frequency and earnings volatility. More recently,
be perceived to manage risk less effectively. Hussainey and Al-Najjar (2011) nd no signicant association between
rms' market beta and future-oriented information. These studies deal
3.2. Prior research only with voluntary disclosures. However, Hassan et al. (2009) nd no
signicant correlation between beta as a proxy for risk levels and either
Two streams of risk measurement literature have emerged from the voluntary or mandatory disclosures.
work of Ball and Brown (1968, 1969). The rst (Almisher & Kish, 2000; In terms of research that examines the impact on risk disclosures,
Beaver & Manegold, 1975; Beaver et al., 1970; Brimble & Hodgson, Linsley and Shrives (2006) argue that the association between risk
2007; Giner & Revert, 2006; Lev & Kunitzky, 1974; Papadamou & levels (measured by beta) and risk disclosure level can be hypothesised
Tzivinikos, 2012) explores how accounting-risk measures can serve positively or negatively. A positive relationship may be explained on the
as proxies for market risk and express changes in systematic risk accu- basis of managers in higher-risk rms providing information to explain
rately. The second, grounded in the CAPM, interprets associations be- the extent to which they can manage these higher risks successfully. A
tween market- and accounting-risk measures theoretically (Baginski negative relationship may be hypothesised on the basis that higher-
& Wahlen, 2003; Bowman, 1979; Chiou & Su, 2007; Hamada, 1972). risk rms may not wish to attract market attention.
This literature explains how market-risk measures, volatility of However, Linsley and Shrives (2000, 2005, 2006) do not nd
market returns, beta and standard error of the CAPM may respective- signicant associations between these two variables, suggesting that
ly measure rms' total, systematic and unsystematic risks. Leverage risk disclosure levels are related more to rm size than to risk.
and the current ratio are accounting-risk measures suggested as Abraham and Cox (2007) nd a positive association between risk
proxies for rms' nancing and liquidity risks. levels, measured by the variance of stock returns and risk disclosures.
There are also two streams of risk disclosure literature. The Lin, Owens, and Owers (2010) reveal that mandatory information
rst focuses on the impact of mandatory risk disclosure require- about the market risk is positively associated with rms' total, system-
ments (e.g., Securities and Exchange Commission (SEC) requirements atic and unsystematic risks. Vandemaele et al. (2009) also report a
such as Financial Reporting Release No.48 (FRR 48), issued in 1997)5 positive relationship between systematic risk and aggregated risk-
disclosure levels. Nevertheless, Marshall and Weetman (2002) indi-
cate that high-risk rms are likely to disclose less than those of mar-
ginally lower risk.
4
Verrecchia (2001) explains that both mandatory and voluntary disclosures can re-
duce information asymmetry, resulting in increasing disclosure incentives and enhanc-
ing the efciency of disclosure choices and the working of the capital markets. Dye's
(1986 and 1990) work is inconclusive, nding that mandatory disclosure affects incen-
tives for voluntary disclosure both positively (1986) and negatively (1990). However,
6
Gigler and Hemmer (1998), Marshall and Weetman (2002) and Deumes and Knechel The main ndings report on the empirical usefulness of the SEC forms, either gen-
(2008) support Dye's earlier work. erally (Rajgopal, 1999) or specically (tabular form: Hodder & McAnally, 2001 and VaR
5
FRR 48 deals with the market risk of derivatives. Three quantitative formats for risk form: Linsmeier et al., 2002, and Jorion, 2002) on stock returns, share price sensitivity
disclosure are stipulated: sensitivity analysis, value at risk (VaR) and tabular formats, and prediction of variability in trading revenues and portfolios. Jorgensen and
with the objective of disclosing the impact of changes in market rate and prices on cash Kirschenheiter (2003, 2012) investigate the impact of voluntary and mandatory risk
ows, earnings and fair values (SEC, 1997). disclosures on rms' stock returns, betas and future cash ows.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
4 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

In summary, the literature indicates mixed evidence with respect to 3.3.3. Control variables
the associations between market-risk measures7 and risk disclosures.
Therefore, we formulate the following non-directional hypotheses: 3.3.3.1. Other rm characteristics. We control for four factors used fre-
quently in prior research. First, rm size has been widely used in prior
H1. Aggregated, voluntary and mandatory risk disclosures are likely disclosure literature documenting a positive association between rm
to be inuenced signicantly by total risk. size and disclosure (e.g., Chavent et al., 2006). The rationale behind
the positive association with risk disclosures is that managers in
H2. Aggregated, voluntary and mandatory risk disclosures are likely large rms will disclose more risk information than those in small
to be inuenced signicantly by systematic risk. rms because the cost of providing risk information in large rms is
likely to be lower relative to small rms. Additionally, small rms
H3. Aggregated, voluntary and mandatory risk disclosures are likely are more sensitive to the disadvantages of revealing risk information
to be inuenced signicantly by unsystematic risk. to their rivals in the market. Risk disclosure research, however, re-
ports mixed results. While Beretta and Bozzolan (2004) do not nd
H4. Aggregated, voluntary and mandatory risk disclosures are likely that size has a signicant impact on aggregated risk disclosures,
to be inuenced signicantly by risk-adjusted returns. Linsley and Shrives (2006) and Abraham and Cox (2007) nd a posi-
tive association between these two variables.
3.3.2. Accounting-risk measures and risk disclosure Second, protability is another factor that may affect risk disclosure
Both leverage and liquidity impact disclosure levels (Ferguson, levels. Signalling theory suggests that managers are likely to reveal
Lam, & Lee, 2002; Malone, Fries, & Jones, 1993; Wallace, Naser, & good news to the market to avoid any undervaluation of their shares
Mora, 1994). Signalling theory suggests that the debt and current ra- (Giner, 1997). The positive impact of corporate protability on levels
tios are positively related to corporate disclosure levels. Jensen and of disclosure is supported by empirical research (e.g., Chavent et al.,
Meckling (1976), however, argue that highly leveraged and highly 2006; Giner, 1997; Wallace & Naser, 1995). High-protability rms,
liquid rms have higher monitoring costs. Such rms may seek to re- therefore, have relatively greater incentives to signal their performance
duce these costs by disclosing more information in their annual re- quality and their ability to manage risks successfully.
port narratives. Third, Khurana, Pereira, and Martin (2006) argue that because dis-
Foster (1986) argues that companies with high debt occasionally closure enhances rms' ability to obtain external nancing by reduc-
disclose certain types of information to indicate that they have not vi- ing information asymmetry, rm growth is likely to positively impact
olated the conditions of any agreements. Voluntary disclosure re- disclosure levels. This argument is supported both by their empirical
duces information asymmetry, thereby decreasing the borrower's evidence and that of Chavent et al. (2006) and O'Sullivan, Percy,
risk of default and in turn reducing the cost of capital (Baiman & and Stewart (2008). High-growth rms, therefore, may have positive
Verrecchia, 1996). In addition, Ahmed and Courtis (1999) nd that incentives to provide risk disclosures in order to demonstrate that
high-leverage rms are more likely to have higher monitoring costs, they manage risks effectively.
making these rms more likely to provide information to reduce Fourth, rms with low levels of information asymmetry due to
these costs. their high levels of disclosure are likely to pay high levels of divi-
There is a clear theoretical justication for the association be- dends, as evidenced by Khang and King (2006) and Hussainey and
tween liquidity and disclosure levels, based on reducing monitoring Al-Najjar (2011). We control for rms' dividend effects and expect
costs (e.g., Beyer et al., 2010). The empirical evidence, however, doc- to nd a positive association between risk disclosures and dividends;
uments mixed results. For instance, Cooke (1989) and Graham, rms with high-risk disclosures may be more motivated to pay higher
Harvey, and Rajgopal (2005) nd that highly liquid rms have incen- levels of dividends to compensate their investors for their high risk
tives to provide more voluntary information. Wallace et al. (1994) levels.
nd that low-liquidity rms are more willing to provide more mandato-
ry or voluntary information. Wallace and Naser (1995) and Owusu-
Ansah (1998) do not nd empirical evidence associating the extent of 3.3.4. Corporate governance (CG) characteristics
mandatory disclosure with rms' liquidity.
Empirical research on the association between risk disclosures and 3.3.4.1. Board characteristics. The literature suggests that several board
leverage also offers mixed results. For example, Abraham and Cox characteristics may inuence disclosure. First, Gul and Leung (2004)
(2007), Linsley and Shrives (2006) and Rajab and Handley-Schachler suggest further research on the impact of board size on corporate
(2009) nd no signicant association between leverage and risk disclo- disclosure. Jensen (1993) argues that a large board size may lead to
sures, while Marshall and Weetman (2007) and Deumes and Knechel less effective coordination, communication and decision-making. Prior
(2008) nd a positive association between leverage and aggregated research provides mixed results; for instance, Cheng and Courtenay
risk disclosures. Only Marshall and Weetman (2007) examine the asso- (2006) nd that the impact of board size on disclosure is non-
ciation between risk disclosures and liquidity, and they nd that the li- signicant. Hussainey and Al-Najjar (2011) and Byard, Li, and Weintrop
quidity ratio is positively associated with risk disclosures. (2006) nd positive and negative associations between board size and
Thus the evidence on the relationship between nancing and liquid- disclosure, respectively.
ity risks is mixed. We therefore adopt the following non-directional Second, board composition (executive directors, or EDs, and non-
hypotheses: executive directors, or NEDs) and independence (dependent NEDs
and independent NEDs) have also been highlighted as potentially
H5. Aggregated, voluntary and mandatory risk disclosures are likely important corporate governance variables in prior research (e.g.,
to be inuenced signicantly by the nancing risk. Abraham & Cox, 2007; Chen & Jaggi, 2000; Cheng & Courtenay,
2006; Gul & Leung, 2004). The role of NEDs in countries such as the
H6. Aggregated, voluntary and mandatory risk disclosures are likely UK may be rationalised in terms of reducing agency costs and
to be inuenced signicantly by the liquidity risk. strengthening the motivation for risk disclosures (Abraham & Cox,
2007). Prior research further distinguishes between NEDs who have
7
The Sharpe ratio is a proxy for rm risk levels (Scholz & Wilkens, 2005); rms with
businesses or relationships with management from those who do
higher Sharpe ratios may be more attractive to investors by exhibiting lower levels of not. Chen and Jaggi (2000) and Cheng and Courtenay (2006) nd a
risk relative to excess returns. positive association between INEDs and general disclosure; Abraham

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 5

and Cox (2007), however, nd a positive association between INEDs two respects. First, we measure three different levels of risk disclo-
and risk disclosures. sures (aggregated, voluntary, and mandatory) as opposed to bad
Third, Jensen (1993) suggests, from an agency theory perspective, or good news (Kothari et al., 2009) or forward-looking information
that rms should separate CEO responsibilities and roles from those (Hussainey et al., 2003; Muslu et al., 2011). Second, as with Kothari
of the board chair. Gul and Leung (2004) nd that rms where et al. (2009), we count the number of risk statements in the annual
those roles are combined (CEO duality) disclose signicantly less report as a whole rather than restricting the search to specic sec-
information than do other rms. Cheng and Courtenay (2006), how- tions (e.g., certain narrative sections: Hussainey et al., 2003; Manage-
ever, nd that the impact of CEO duality is non-signicant. ment and Discussion Analysis (MD&A): Muslu et al., 2011). The
These considerations motivate us to include several proxies for following sub-sections discuss the detailed steps involved.
board characteristics: board size (BZ), proportion of non-executive
directors (PNED), proportion of independent non-executive directors
4.1. The automated content analysis steps
(PINED) and chief executive ofcer (CEO) duality.
A rms' risk disclosure level is captured in three steps. First, we com-
3.3.4.2. Ownership structure. Managers may have incentives to provide
pile a comprehensive list of risk-related keywords to identify the nal
more information to investors to reduce the information costs arising
risk-word list. Our list relies on three main sources: rst, prior academic
from varied ownership (Verrecchia, 1990). Marshall and Weetman
and professional research on risk concepts (e.g., Bernstein, 1996;
(2007) argue that higher levels of insider control, measured by the
Luhmann, 1996; Ricciardi, 2004; AICPA & CICA, 2000); second, Roget's
percentage of closely held shares (CHS), are associated with lower
Thesaurus, by sourcing all relevant synonyms for words already identi-
levels of risk disclosure. Their ndings support the argument that
ed; and third, other words indicative of risk, identied by reviewing
managers of rms with high levels of insider control as measured
the annual report narratives. To examine the extent to which words fea-
by CHS have less incentive to disclose more risk information.
tured in the initial list are used, an intensive text-search is conducted
Agency theory suggests that rms with greater (lower) inside
using Nudist 6 for a random sample of 15 annual report narratives.
(outside) ownership are likely to be more (less) secretive and less
We omit all words not appearing in this text-search. We thus identify
transparent (Brown, Beekes, & Verhoeven, 2011; Deumes & Knechel,
the nal risk word list,8 which is again examined for reliability and va-
2008). In structures where there is a greater separation of ownership
lidity, as discussed in Section 4.2.
and control, investors' monitoring costs are likely to be higher in com-
Second, using the specic instructions for the Nudist software, we
parison to rms with a lesser separation of ownership and control. To
design a programme to search for the risk-related keyword list that
reduce this conict, rms may provide more risk disclosures (e.g.,
was previously generated. We count all statements containing at least
Deumes & Knechel, 2008; Eng & Mak, 2003; Gelb, 2000).
one relevant risk word. These statements are used as a proxy for aggre-
gated risk disclosures, with no distinction made between voluntary and
3.3.4.3. Audit environment. The audit environment can be considered
mandatory risk disclosures. An analysis of the UK regulatory and profes-
as one element of corporate governance (Carcello & Neal, 2000).
sional literature discussed in Section 2 enables the identication of ac-
Strong CG requires an effective audit environment, which can be at
counting standards, topics or themes associated with mandatory risk
least partially captured by characteristics such as the audit committee
disclosures.9 To differentiate between voluntary and mandatory state-
composition, audit fees, auditor rotation, and auditor ratication. An
ments, we correlate all aggregated risk statements with mandated risk
effective audit environment reduces the conict between owners
topics or themes to obtain the mandatory risk scores; we then exclude
and managers and reduces monitoring costs by providing more informa-
these scores from the aggregated risk scores to determine the voluntary
tion (e.g., Carcello & Neal, 2000, 2003). Hoitash, Hoitash, and Bedard
risk disclosures (Appendix 1 illustrates how to obtain those scores).
(2009) nd a positive association between audit committees and
Third, all scores are tested manually and statistically to ensure
disclosures.
their reliability and validity, as discussed in the following sub-section.
In an effective audit environment, managers are likely to be better
informed of their risks via detailed internal risk reporting on the iden-
tication of risks and the management of those risks. As a result, man- 4.2. The reliability and validity of risk disclosure scores
agers may have incentives to convey this information to investors
because they do not incur additional collection and preparation costs. We check the reliability and validity of the risk disclosure scores in
two stages. First, we examine the extent to which the nal word list
4. Measuring aggregated, voluntary and mandatory risk captures statements with a risk focus in annual report narratives. To
disclosures using automated content analysis this end, we read 30 randomly selected statements from the Nudist out-
put for 15 rms. We nd that the nal risk keyword list is successful
Previous research has used content analysis to measure corporate (80%) in identifying statements indicating risk. Second, after calculating
disclosure levels (e.g., Beattie, McInnes, & Fearnley, 2004, Beattie, the nal risk disclosure scores, we carry out two post hoc procedures.
McInnes, & Pierpoint, 2008; Botosan, 1997; Botosan & Plumlee, 2002; First, we review the rst-stage statements manually, considering the
Hassan et al., 2009; Kothari et al., 2009). Some research uses content word list's ability to discriminate between voluntary and mandatory
analysis to measure specic types of disclosure: forward-looking infor- risk disclosures (Appendix 1 provides some examples of risk statements
mation (e.g., Hussainey et al., 2003) and risk disclosures (e.g., Abraham that are captured by Nudist 6). We nd that the keywords discriminate
& Cox, 2007; Beretta & Bozzolan, 2004; Linsley & Shrives, 2006). There between these disclosures accurately. Second, we use Cronbach's Alpha
are two principal methods of content analysis: the manual method to examine the reliability of the aggregated, voluntary and mandatory
(Abraham & Cox, 2007; Beattie et al., 2004, 2008; Beretta & Bozzolan, risk disclosure scores. This test measures how well a data set captures
2004; Linsley & Shrives, 2006) and the automated method (Gruning,
2011; Hussainey et al., 2003; Kothari et al., 2009; Muslu et al., 2011). 8
This list includes the following words: risk*, loss*, decline (declined), decrease
Either method may employ the word, sentence or line as the unit of (decreased), less, low*, fail (failure), threat, verse (versed; reverse; reversed), viable,
analysis. Hussainey et al. (2003), Beattie et al. (2004, 2008) and Muslu against, catastrophe (catastrophic), shortage, unable, challenge (challenges), uncertain
et al. (2011) use the sentence as the unit of analysis; Gruning (2011) (uncertainty; uncertainties), gain (gains), chance (chances), increase (increased), peak
(peaked), uctuate*, differ*, diversify*, probable* and signicant*. Words denoted by * also
uses a combination of word, sentence and line. include derivatives of the original.
Our study adopts the automated method and uses the sentence as 9
We examine the following topics or themes: derivatives, nancial instruments, in-
the text unit but may be distinguished from the previous research in vestments, segments and foreign currency.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
6 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

an underlying construct. For the computed risk disclosure scores, In total, therefore, six risk measures are used to capture the rm risk
Cronbach's Alpha is 90%, indicating that consistency between the levels.
three risk disclosure scores is high when compared with the generally We control for rm size measured by the natural logarithm of
acceptable social science measure of 70% (Bryman, 2004; Deumes & market capitalisation (Worldscope item, WC08001), rm protability
Knechel, 2008). We conclude that our computed disclosure scores are measured by the natural logarithm of Return on Equity (ROE)
reliable. (Worldscope item, WC08301), rm growth measured by the natural
logarithm of growth in earnings (Datastream item, E018) and dividend-
yield measured by the natural logarithm of the ratio of the most recent
5. Methods full-year dividends divided by the current share price (Worldscope
item, WC09402).
5.1. Data collection and sample selection Moreover, we control for corporate governance mechanisms,
including board characteristics, ownership structure and audit envi-
Thomson One Banker is used to obtain a list of UK FTSE all-share ronment. Board characteristics include board size (BZ), which is mea-
companies. Financial rms are excluded, as in the case of prior re- sured by the natural logarithm of the total number of board directors.
search (Abraham & Cox, 2007; Beretta & Bozzolan, 2004; Linsley & The proportion of independent non-executive directors (PINED) is
Shrives, 2006), because of their distinctive regulation and accounting measured by the proportion of independent non-executive directors
practices. Cross-listed rms are excluded to avoid non-UK regulatory relative to the BZ. CEO is a dummy variable with a value of 1 if
inuences (see Abraham & Cox, 2007; Marshall & Weetman, 2002; the CEO is also chairman of the board of directors and a value of 0
Rajab & Handley-Schachler, 2009). These criteria yield a list of 339 otherwise.11
rms. We collect annual reports for these rms via either Thomson Ownership structure includes CHS and NOSH_Factor to capture
One Banker or, if unavailable, the company's website, for the nancial the insider ownership and the outsider ownership, respectively. CHS
years ending within the period 30 June 2005 to 30 June 2009. The re- is closely held share in a publicly traded company in which a small
search focuses on annual reports because they remain a primary group of shareholders control the majority of the shares. NOSH_Factor
source of information for investors, and there is increasing usage of is the average of two-principal factors (e.g., Larcker, Richardson,
these reports, indicating value relevance to investors (e.g., Beattie et & Tuna, 2007) that combine four types of shares. These are: (a)
al., 2004, 2008). This period is chosen because IFRS became mandato- NOSHFF, free-oat shares, the percentage of total shares in issue
ry for UK-listed companies in 2005. Any rm without a complete time available to ordinary investors; (b) NOSHST, total strategic holdings,
series is excluded; this approach reduces the sample from 1356 the percentage of total shares in issue held strategically and not avail-
rm-years (339 rms) to 1216 rm-years (304 rms). able to ordinary investors; (c) NOSHIC, investment-company-held
All annual reports are converted to text les so they are readable by shares, the percentage of total shares in issue held as long-term strate-
Nudist 6 with the exception of 14 annual reports that could not be gic holdings by investment banks or institutions seeking a long-term
converted to text les. Thus, the total sample size is 1190 rm-years return; and (d) NOSHCO, cross-holdings, the percentage of total
(290 rms). To minimise the effect of outliers, we transform the data shares in issue held by one company in another. We validate the
to natural logarithms,10 which also improves our variables' distribu- NOSH_Factor by using both the KaiserMeyerOlkin (KMO) measure
tions. These 290 rms are distributed within eight main sectors: indus- of sampling adequacy (0.57 against 0.50 as a common value for
try (I) 103 (35.5%), service (S) 81 (27.9%), consumer (C) 34 (11.7%), KMO) and Bartlett's test of sphericity (Chi-square 376.349 at p-value
health (H) 16 (5.5%), material (M) 18 (6.3%), utilities (U) 5 (1.7%), tele- of 0.000).
communication (T) 24 (8.3%), and technology (Tec) 9 (3.1%). To avoid The audit environment is captured by Audit_Aggregated, which is
effects from the dissimilar size of these eight sectors and based on the aggregated score of four characteristics.12 These are the audit
their similarities, we merge material & industry (M_I), health & service committee composition (independence of the members), audit fees,
(H_S), consumer & utilities (C_U) and telecommunication & technology auditor rotation, and auditor ratication (permissible shareholder
(T_Tec). ratication of the selection of auditors). We obtain these scores
from CGQ.
Table 1 provides descriptive statistics for the variables.13 For
5.2. Variables: measurement and description
the dependent variables, the aggregated risk disclosures (ARD) ex-
hibit the highest mean (2.378) and mandatory risk disclosures
The dependent variables for aggregated, voluntary and mandatory
risk disclosures are measured by counting the number of statements
in the annual report narratives containing one or more words from
the nal risk-word list.
For independent variables, we employ various risk measures. In
11
terms of market-risk measures, volatility of market returns (Datastream We collect these variables manually from the BoardEx database over a 4-year peri-
od. The descriptive statistics (not reported in Table 1) indicate that 1,035 (89.2%) out of
item, 009E) is used as a measure of total risk, and beta (Datastream item,
1,069 rm-years are not characterised by CEO duality. In these 1,069 rm-years, there
897E) and standard error of CAPM (Datastream item, 519E) are used as are 13,666 directors; 1,489 EDs (approximately 11%) and 12,177 NEDs (approximately
measures for systematic and unsystematic risks, respectively. We also 89%). Of these NEDs, 9,443 (77.6%) may be described as independent. Pearson coef-
employ the Sharpe ratio (Datastream item, 457E) to reect rms' risk- cients indicate potential multi-collinearity between ED and NED (0.950 at p-value
adjusted returns. In terms of accounting-risk measures, we use ratio 0.000); this result is conrmed by VIF (15.8). We therefore exclude ED from our empir-
ical models.
analysis for further insight into unsystematic risk. We use the leverage 12
In line with constructing indices used to capture board characteristics and owner-
(Worldscope item, WC08231) and current ratio (Worldscope item, ship structure, there are also ranking methods by which some professional rms create
WC8106) to measure the nancing and liquidity risks, respectively. indices used to rate rms' CG. One popular form of these indices is the Corporate Gov-
ernance Quotient (CGQ) from FTSE Institutional Shareholder Services (ISS), rated by
the Risk Metrics Group (RMG). This rating is based on a range from 0 to 100 for 61 gov-
ernance elements across eight characteristics, including audit environment (e.g.,
Brown et al., 2011).
13
Table 1 also conrms the extent to which our variables are normally distributed.
10
The transformation does not affect the original pattern of these variables; we check Comparing the mean with the median and the shape of each variable distribution for
the results of the OLS regression model before and after the data transformation and both kurtosis and skewness suggests that all variables are normally distributed. This
the results are virtually identical (see Hair, Black, Babin, & Anderson, 2009: 7677). conclusion is conrmed by KolmogorovSmirnov and ShapiroWilk tests.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 7

(MRD) the lowest (1.428). The results suggest that UK rms disclose slope coefcient of both industry and year impacts. These are: M_I
approximately 40% more risk information voluntarily than is man- (material and industry), H_S (health and service), C_U (consumer
dated. This outcome is consistent with Deumes and Knechel (2008), and utilities), and T_Tec (technology and telecommunication) sectors;
who nd that managers in low-regulation environments are highly mo- 2005, 2006, 2007, and 2008 are the study periods. ijt is the standard
tivated to provide voluntary risk information in response to economic error of residual for rm i in sector j in year t.16
incentives. The Pearson correlation matrix,14 not tabulated, used to The full or the conditional model (stage 2):
measure the strength and the direction of the linear association be-
tween any pair of variables, provides consistent evidence that voluntary  
TR; SR; Un R; RAR;
risk disclosures are signicantly and positively associated with manda- RDijt 1 1 2
FR; LR
tory risk disclosures (p b 0.01). Thus, UK rms exhibiting higher levels 2 3
ijt

of mandatory risk disclosure are also more likely to make more volun- SE; PE; GE; DE;
6 BZ; PNED; PINED; CEO; 7
tary risk disclosures. Our evidence supports Dye (1986) and is consis- 2 6 7
4 CHS; NOSHA Factor; 5 ijt
tent with Gigler and Hemmer (1998), Marshall and Weetman (2002)
Audit Aggregated
and, more recently, Ya (2011). Pearson correlation coefcients (not ijt

tabulated) indicate signicant associations between risk disclosure


types and all exploratory variables. Some of those signicant associa-
where all variables have the same denitions as in the null model, while
tions, specically the volatility of the market returns and size, are con-
( + 1) and ( + 2) are the slopes of the independent and control
sistent with prior research (e.g., Linsley & Shrives, 2006; Marshall &
variables, respectively, and are allowed to vary across industries over
Weetman, 2002), which corroborates the validity of our risk disclosure
years. TR, SR, Un_R, RAR, FR and LR are the total, systematic, unsystematic,
scores.
risk-adjusted returns, nancing and liquidity risks, respectively, for rm i
in sector j in year t. SE, PE, GE and DE are the rm size, protability,
growth and dividend effects, respectively, for rm i in sector j in year t.
5.3. The empirical model
BZ, PNED, PINED, CEO duality, CHS, NOSHA_Factor and Audit_Aggregated
are the board size, the proportion of non-executive directors, the pro-
We regress aggregated, voluntary and mandatory risk disclosures
portion of independent non-executive directors, chief executive ofcer
on six explanatory variables, representing rm the risk levels, and
duality, closely held shares, the average of two principal factors that are
consider the impact of eleven control variables, representing other
proxies for four types of shares and the aggregated score for the audit
rm characteristics and corporate governance mechanisms, using
environment, respectively, for rm i in sector j in year t.
the Linear Mixed Model (LMM). LMM avoids the problems that are
frequently encountered when using other models (e.g., Ordinary
6. Empirical results
Least Squares (OLS) and Fixed-Effect Model (FEM); see Gow et al.,
2010) that assume complete independence of observations.15 We
6.1. Aggregated and voluntary risk disclosures
employ LMM in two consecutive stages. The rst stage is the null or
the unconditional random-effect model. We measure the impact of
The random-effect estimates, under the baseline model of Table 2, in-
industry and year separately on the aggregated, voluntary and man-
dicate that the variances of aggregated and (voluntary) risk disclosures
datory risk disclosures. This model, therefore, is used as a baseline
are signicant within and between rms across industries over the period
(BM) to evaluate the extent to which the full or the conditional
20052008; the Z values of the Wald test are 16.60 (16.60) and 2.22
model (FM), incorporating all independent variables, can interpret
(2.32) at p-values of 0.000 (0.000) and 0.026 (0.020), respectively.
risk disclosure variations across industries and over years, as with
To investigate these results further, we calculate the intra-class cor-
the second stage. These stages can be described as follows:
relation coefcients (ICC),17 which explain the proportion of variation
The null or the unconditional model: one-way ANOVA with random-
in aggregated or voluntary risk disclosures that can be attributed to
effect model (stage 1)
within- and between-rm variances across industries and years. The re-
sults indicate that 17.2% of the variation in aggregated risk disclosure is
RDijt 1 2 M I; H S; C U; T Tec; 2005; 2006; 2007; 2008 ijt attributable to between-rm variance across industries and years; the
1 remainder (82.8%) reects the variation in aggregated risk disclosures
caused by within-rm variance across industries and years. Similarly,
where RD is the aggregated, voluntary and mandatory risk disclosure 22.6% of the variation in voluntary risk disclosures can be attributed to
scores for rm i in sector j in year t, 1 is the intercept and 2 is the between-rm variance across industries and years.

14
In addition to measuring the strength and direction of the linear association be-
16
tween any pair of variables, the Pearson coefcients for both independent and control In order to determine whether residuals are normally distributed, we conduct vi-
variables may also be used to diagnose multi-collinearity. The greater the inter- sual and statistical diagnostics. Accordingly, we generate the standardised residuals
correlation of these regressors, the higher the likelihood of the tolerance coefcients and predicted values for the dependent variable (ARD, VRD and MRD). Both the QQ
approaching zero and exhibiting collinearity. If the tolerance of any predicted variable plot and the normality curve with histogram for standardised residuals and predicted
is less than 0.1 (alternatively, if the Variance Ination Factor (VIF) is more than 10), values of ARD, VRD and MRD visually support the validation of the normality assump-
this suggests multi-collinearity (Field, 2009: 223225). These tests (not reported) indi- tion (e.g., Snijders & Berkhof, 2008). We then use summary statistics for those two var-
cate that no regressors exhibit this problem. Additionally, the DurbinWatson regres- iables, namely, by comparing the mean with the median relative to the shape of the
sion diagnostic is used to examine the independence of residual errors (auto- distribution indicated from skewness and kurtosis. These conclusions are further con-
correlation) for each regression model. The results indicate that all DurbinWatson rmed by using the KolmogorovSmirnov test, which indicates acceptance for the
values are approximately equal to 2 (the generally accepted benchmark). null-hypothesis for the normality assumption. Such conclusions are consistent with
15
Using LMM permits the consideration of residual dependency by treating both in- the fact that our main variables do not exhibit the problem of outliers and lack of nor-
dustry and year (level 2 grouping unit) as random factors in adjusting the risk disclo- mality, as indicated in notes 13 and 14.
17
sure of each rm (level 1 unit) and in providing many structures. These include rst- The ICC for residuals may be calculated as the variance of estimate residual/(variance of
order autoregressive structure, AR (1); rst order autoregressive moving average estimated residual + variance of estimate for industries and years). To get ICC for the ran-
structure, ARMA (1)) of error at each level (e.g., Field, 2009; Gelman & Hill, 2009; dom factor, reecting the effects of the cross-sectional (industries) and time series (years),
Hox, 2010). we replace the denominator by the variance of estimate for industries and years.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
8 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

Table 1
Descriptive statistics for dependent (De), independent (In) and control variables.18

Variables Mean Median 25% 75% Skewness Kurtosis Observations

ARD Dependent (De) 2.378 2.386 2.243 2.505 0.064 0.210 1160
VRD 2.321 2.330 2.187 2.445 0.166 1.356 1160
MRD 1.428 1.454 1.255 1.623 0.438 0.362 1160
TR Independent (In) 0.513 0.528 0.425 1.303 0.626 0.428 1140
SR 0.0237 0.000 0.722 3.102 0.1674 0.1335 1119
Un_SR 1.775 1.698 0.290 0.679 1.000 1.698 1152
RAR 1.415 1.385 0.430 0.192 1.078 1.724 1160
FR 1.650 1.784 1.105 2.313 1.390 2.061 1014
LR 0.108 0.104 0.479 2.982 0.041 0.232 1140
SE Control (other rm characteristics) 5.921 5.835 5.398 6.310 0.692 0.232 977
PE 1.300 1.300 .454 5.788 1.100 1.50 992
GE 2.210 2.270 1.502 7.117 1.100 2.310 1160
DE 1.6012 1.6270 1.4701 1.754 1.090 2.439 852
BZ Control (governance characteristics) 1.078 1.079 1.000 1.176 0.184 1.200 1069
PNED 0.701 0.750 0.583 0.818 0.397 2.489 1066
PINED 0.907 0.923 0.866 1.000 0.992 3.072 1069
CHS 0.856 0.944 0.721 1.380 0.480 1.763 1160
NOSH_Factor 0.032 0.053 0.2065 0.1504 0.469 2.345 1160
Audit_Aggregated 4.24 4.24 4.000 5.000 0.938 1.947 1160

This table explains the descriptive statistics of the dependent (risk disclosure), independent (risk measures) and control variables (other rm characteristics including rm size,
protability, growth and dividends; and corporate governance characteristics including board characteristics, ownership structure and audit characteristics).
ARD is aggregated risk disclosure, measured by the natural logarithm of the total number of risk statements in the rm's annual report narratives; VRD is the voluntary risk
disclosure, measured by the natural logarithm of the total number of risk statements reveal voluntarily; MRD is the mandatory risk disclosure, measured by the natural
logarithm for the total number of risk statements revealed mandatorily.
SE is the rm's size effect, measured by the natural logarithm of market capitalisation; PE is the rm's protability effect, measured by the natural logarithm of the rm's Return on
Equity (ROE); GE is the rm's growth effect, measured by the natural logarithm of earnings growth; and DE is the rm's dividend effect, measured by the natural logarithm of the
rm's dividend-yield.
Board characteristics, from CG, include: BZ is board size measured by the natural logarithm of the total number on the board of directors; PNED expresses the proportion of
non-executive directors; PINED expresses the proportion of independent non-executive directors relative to the BZ; ownership structure, from CG, includes CHS and
NOSH_Factor to capture the insider ownership and the outsider ownership, respectively. CHS are closely held shares in a publicly traded company in which a small group of
shareholders control the majority of the shares. NOSH_Factor is the average of two-principal factors (e.g., Larcker et al., 2007) that combine four types of shares, capturing
outsider ownership structure. These are: (a) NOSHFF, free-oat shares, the percentage of total shares in issue available to ordinary investors; (b) NOSHST, total strategic
holdings, the percentage of total shares in issue held strategically and not available to ordinary investors; (c) NOSHIC, investment-company-held shares, the percentage of total
shares in issue held as long-term strategic holdings by investment banks or institutions seeking a long-term return; and (d) NOSHCO, cross-holdings, the percentage of total
shares in issue held by one company in another.
Audit environment, from CG, is captured through Audit_Aggregated, which is the aggregated score for audit characteristics, including audit committee composition (independence
of the members), audit fees, auditor rotation, and auditor ratication (permissible shareholder ratication of the selection of auditors). We obtain these scores from CGQ.

To identify which factors explain these aggregated and voluntary The results indicate that, consistent with our a priori expecta-
risk disclosure variations, we run the full or the conditional model. tions and with previous empirical research (Abraham & Cox, 2007;
Table 2 indicates that the aggregated and voluntary risk disclosures19 Vandemaele et al., 2009), rms with higher systematic, nancing
are inuenced signicantly and positively by systematic risk, nancing and risk-adjusted return risks are more likely to disclose more
risk and risk-adjusted returns. While the coefcient estimates for aggre- voluntary risk information. Agency and signalling theories suggest
gated risk disclosures on these variables are 0.045, 0.064, and 0.038 at that managers of high-risk rms have greater incentives to disclose
p-values of 0.044, 0.000, and 0.0 01, respectively, the coefcient esti- more voluntary information.
mates for voluntary risk disclosures are 0.034, 0.061 and 0.041 at Our results also suggest that rms characterised by high volatility
p-values of 0.004, 0.000 and 0.008, respectively. Furthermore, the of market returns appear less willing to provide more voluntary risk
table shows that higher variability in the market returns has a signi- information. This nding reects the theoretical arguments of
cantly negative impact on the aggregated (voluntary) risk disclosures, Linsley and Shrives (2006) and the empirical ndings of Marshall
as the coefcients on these variables are 0.144 ( 0.151) at and Weetman (2002, 2007). We therefore accept H1, H2, H4 and
p-values of 0.009 (0.007). H5, rejecting H3 and H6.
Our results generally suggest that risk disclosure levels in the UK
annual reports reect underlying risk levels. This phenomenon pro-
vides some support for the UK approach to risk disclosures of limited
mandatory regulation reinforced by recommendation and encourage-
ment. Our evidence, however, also suggests that the current regulato-
18
CEO duality is one variable of CG, which as a dichotomous variable was measured ry regime is consistent with rms characterised by higher levels of
as a dummy variable with a value of 1 if the chief executive ofcer was also the chair-
variability of market returns disclosing relatively less risk information
man of the board of directors with a value of 0 otherwise. The descriptive statistics in-
dicate that 1035 (89.2%) out of 1069 rm-years are not characterised by CEO duality. voluntarily than other rms.
19
To assess the goodness of t of this model, the principal rule is that if the differ- In terms of the control variables, the coefcients for aggregated
ences of 2 Log Likelihood (2LL) decrease, the full model is improved. To examine (voluntary) risk disclosures on size and dividend-yield are signicant
such improvements statistically, change Chi-square should be conducted. Accordingly, and positive at p-values 0.000 (0.000) and 0.061 (0.100), respectively.
if the difference between the 2LL for the full and the baseline modes is greater than
the value of the change Chi-square (the critical or cut-off point of the Chi-square dis-
This result suggests that larger and high-dividend-yield rms are
tribution), the model ts. On that basis, the full model for ARD, VRD and MRD indicates more likely to exhibit high levels of aggregated and voluntary risk dis-
signicant improvement. closures (Abraham & Cox, 2007; Linsley & Shrives, 2006). Signalling

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 9

Table 2
Linear Mixed Model results of the impact of risk levels on aggregated, voluntary and mandatory risk disclosures.

In/De Expected sign Aggregated risk disclosures Voluntary risk disclosures Mandatory risk disclosures

Baseline model Full model Baseline model Full model Baseline model Full model

Intercept 0.767*** 0.746*** 0.541**


(0.001) (0.001) (0.037)
TR ? 0.144*** 0.151*** 0.043
(0.009) (0.007) (0.759)
SR ? 0.045** 0.034*** 0.027
(0.044) (0.004) (0.327)
Un_SR ? 0.157 0.106 0.256
(0.790) (0.891) (0.847)
RAR ? 0.038*** 0.041*** 0.035
(0.001) (0.008) (0.157)
FR ? 0.064*** 0.061*** 0.073***
(0.000) (0.000) (0.008)
LR ? 0.217 0.221 0.234
(0.184) (0.178) (0.396)
SE + 0.087*** 0.086*** 0.092***
(0.000) (0.000) (0.000)
PE + 0.011 0.009 0.023
(0.670) (0.709) (0.599)
GE + 0.021 0.021 0.016
(0.878) (0.882) (0.477)
DE + 0.061* 0.051* 0.189***
(0 .087) (0.100) (0.002)
BZ ? 0.435*** 0.433*** 0.436***
(0.000) (0.000) (0.000)
PNED ? 0.193*** 0.185*** 0.246**
(0.003) (0.004) (0.023)
PINED ? 0.059** 0.058** 0.073*
(0.031) (0.034) (0.100)
CEO duality ? 0.014 0.011 0.041
(0.975) (0.981) (0.955)
CHS 0.065* 0.066** 0.014
(0.055) (0.036) (0.345)
NOSH_Factor + 0.015** 0.017** 0.022
(0.036) (0.044) (0.883)
Audit_Aggregated + 0.023*** 0.017** 0.045
(0.010) (0.016) (0.759)
1-Fixed effect
Intercept (F value) 20543.16*** 15454.64*** 21757.61***
2-Random effect (0.000) (0.000) (0.000)
(1) Variance estimate: 0.024 0.024 0.085
Residual 0.005 0.007 0.003
Intercept (industry/year) 16.60*** 16.60*** 10.85***
(2) Wald Z: (0.000) (0.000) (0.000)
Residual 2.22** 2.32** 0.96
Intercept (industry/year) (0.026) (0.020) (0.338)
Changes 2LL 57.78*** 41.44*** 23.13***
(Change Chi-square) (0.000) (0.000) (0.000)
N 815 815 815

The table provides LMM for each type of risk disclosure after including CG effects. *, **, and *** indicate signicance at 0.1, 0.05, and 0.01, respectively (all two tailed). Variable
denitions are the same as discussed in the previous table. This table contains four main parts, the rst gives the coefcients of each parameter using T test. The second part
assesses the overall model's parameters using both of the xed effect, which statistically examines the intercept of the baseline model, using F test, and the random effect,
which additionally provides the ICC between the residual and intercept, using Wald Z test. The third appraises the model; 2LL is implemented and uses change Chi-square to
test such signicance statistically. The fourth gives the number of observations (N). T, F, Wald Z, and change Chi-square values are given in parentheses.

theory suggests that managers of larger or high-dividend-yield rms aggregated and voluntary risk disclosures at p-values of 0.055
have greater incentives, relative to other rms, to provide risk informa- and 0.036, respectively. These results are consistent with our
tion to signal their greater ability to identify and manage their risks. The prior expectation and some other empirical research (e.g., Gelb,
coefcients for aggregated and voluntary risk disclosures on growth 2000; Marshall & Weetman, 2007). Likewise, the results also indi-
and protability are non-signicant. cate that rms that have a higher outsider ownership (as proxied
In terms of corporate governance characteristics, Table 2 indicates by NOSH_Factor) are likely to provide signicantly higher levels
that rms with high PINED, PNED and large BZ are more likely to dis- of aggregated and voluntary risk disclosures at p-values of 0.036
close signicantly higher levels of aggregated (voluntary) risk disclo- and 0.044, respectively. The results also report that rms with
sures at p-values of 0.031 (0.034), 0.003 (0.004) and 0.000 (0.000), an effective audit environment have incentives to reveal more in-
respectively. We nd that ownership structure has a signicant im- formation about their aggregated and voluntary risk disclosures
pact on providing aggregated and voluntary risk disclosures. The re- at p-values of 0.010 and 0.016, respectively. Table 2 indicates
sults show that rms with lower insider ownership, as proxied by that CEO duality affects neither aggregated nor voluntary disclo-
closely held share or CHS, are likely to provide higher levels of sures signicantly. These results are consistent with prior

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
10 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

research ndings (e.g., Abraham & Cox, 2007; Deumes & Knechel, between-rm effects at a p-value of 0.000. The ICC, therefore,
2008). shows that most variations in mandatory risk disclosures (97%)
can be attributed to variances within-rms across industries over
6.2. Mandatory risk disclosures years.
The full or conditional model indicates that mandatory risk disclo-
The baseline model of Table 2 indicates that variances in mandato- sures are inuenced signicantly and negatively by nancing risk; the
ry risk disclosures are explained by within-rm effects rather than coefcient of this variable on mandatory risk disclosure is 0.073 at a

Table 3
Linear Mixed Model results for low- and high-risk rms of the impact of risk levels on aggregated, voluntary and mandatory risk disclosures.

In/De Expected sign Low-risk rms High-risk rms

Aggregated risk Voluntary risk Mandatory risk Aggregated risk Voluntary risk Mandatory risk
disclosures disclosures disclosures disclosures disclosures disclosures

Baseline Full Baseline Full Baseline Full Baseline Full Baseline Full Baseline Full
model model model model model model model model model model model model

Intercept 1.289*** 1.233*** 0.261*** 0.738*** 0.657*** 0.314**


(0.002) (0.004) (0.007) (0.004) (0.006) (0.050)
TR ? 0.039 0.013 0.266 0.337** 0.305** 0.417
(0.812) (0.940) (0.330) (0.041) (0.011) (0.183)
SR ? 0.048 0.047 0.036 0.081** 0.0652** 0.109
(0.275) (0.288) (0.615) (0.023) (0.017) (0.155)
Un_SR ? 2.387* 2.490* 0.711 1.532 1.347 2.435
(0.010) (0.09) (0.767) (0.329) (0.384) (0.354)
RAR ? 0.034 0.033 0.472 0.015 0.019 0.036**
(0.128) (0.147) (0.199) (0.659) (0.570) (0.500)
FR ? 0.072*** 0.072*** 0.074 0.086*** 0.087*** 0.056
(0.005) (0.000) (0.072) (0.007) (0.006) (0.286)
LR ? 0.465 0.393 0.924 0.137 0.160 0.279**
(0.177) (0.454) (0.100) (0.540) (0.472) (0.045)
SE + 0.109*** 0.094*** 0.147*** 0.098*** 0.104*** 0.053
(0.000) (0.000) (0.000) (0.000) (0.000) (0.181)
PE + 0.032 0.034 0.012 0.013 0.058 0.025
(0.452) (0.435) (0.863) (0.980) (0.911) (0.776)
GE + 0.011 0.049 0.120 0.036 0.031 0.053
(0.672) (0.843) (0.116) (0.133) (0.182) (0.152)
DE + 0.045 0.036 0.057 0.105 0.091 0.330***
(0.337) (0.442) (0.157) (0.123) (0.174) (0.004)
BZ ? 0.428*** 0.426*** 0.397 0.334*** 0.351*** 0.196
(0.000) (0.000) (0.002) (0.006) (0.004) (0.314)
PNED ? 0.185** 0.183** 0.166 0.120 0.121 0.100
(0.040) (0.044) (0.260) (0.352) (0.338) (0.639)
PINED ? 0.026 0.023 0.078 0.130** 0.118* 0.215**
(0.559) (0.608) (0.283) (0.041) (0.062) (0.038)
CEO duality ? 0.039 0.030 0.088 0.056 0.063 0.090
(0.501) (0.612) (0.358) (0.944) (0.937) (0.490)
CHS 0.043 0.026 0.183 0.018 0.016 0.026
(0.743) (0.846) (0.398) (0.235) (0.302) (0.314)
NOSH_Factor + 0.013 0.011 0.031 0.029** 0.032** 0.090
(0.331) (0.410) (0.152) (0.046) (0.027) (0.710)
Audit_Aggregated + 0.022* 0.022* 0.030 0.039 0.050 0.014
(0.089) (0.092) (0.146) (0.811) (0.756) (0.957)
1-Fixed effect
Intercept (F value) 14658.11*** 11641.135*** 5219.60*** 19013.43*** 14335.23*** 13718.843***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
2-Random effect
(1) Variance
estimate:
Residual 0.021 0.021 0.027 0.026 0.079
Intercept 0.006 0.007 0.003 0.005 0.00
(industry/year)
(2) Wald Z:
Residual 10.336*** 10.337*** 8.686*** 8.655*** 9.03***
Intercept 1.854** 1.889** 1.227 1.501
(industry/year)
Changes 2LL 51.74*** 31.33*** 149.01*** 142.75*** 209.07*** 111.80***
(Change Chi-square) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
N 575 575 575 557 557 557

The table provides LMM for each type of risk disclosure under both of low- and high-risk rms. *, **, and *** indicate signicance at 0.1, 0.05, and 0.01, respectively (all two tailed).
Variable denitions are the same as discussed in the previous tables. This table contains four main parts, the rst gives the coefcients of each parameter using T test. The second
part assesses the overall model's parameters using both of the xed effect, which statistically examines the intercept of the baseline model, using F test, and the random effect,
which additionally provides the ICC between residual and intercept, using Wald Z test. The third appraises the model; 2LL is implemented and uses change Chi-square to test
such signicance statistically. The fourth gives the number of observations (N). T, F, Wald Z, and change Chi-square values are given in parentheses.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 11

Table 4
General endogeneity tests.

Statistics and variables Aggregated risk disclosures Voluntary risk disclosures Mandatory risk disclosures

Market-risk Accounting-risk Market-risk Accounting-risk Market-risk Accounting-risk


measures measures measures measures measures measures

Sargan statistics 1.713 1.923 1.506 1.794 2.235 1.516


(0.634) (0.170) (0.681) (0.130) (0.524) (0.197)
Basmann statistics 1.683 1.947 1.479 1.813 2.198 1.524
(0.641) (0.162) (0.687) (0.128) (0.532) (0.194)
Durbin statistics 0.797 1.972 0.875 1.155 0.658 0.616
(0.671) (0.160) (0.645) (0.283) (0.715) (0.433)
WuHaumsan statistics 0.392 1.952 0.430 1.139 0.323 0.608
(0.676) (0.163) (0.651) (0.286) (0.723) (0.435)

This table provides statistics of endogeneity between risk disclosures (ARD, VRD and MRD) and both market- and accounting-risk measures. Sargan and Basmann statistics are used
to examine over-identifying restrictions due to having more than one instrumental variable (the null-hypothesis is the mean of instruments and residuals are 0), these two tests are
based on Chi-square statistic. Durbin, based on Chi-square statistic, and WuHaumsan, based on F-statistic, tests examine the extent to which risk disclosures and risk measures are
exogenous (the null-hypothesis of whether the covariance of endogenous variables and residuals equal 0). *, **, and *** indicate signicance at 0.1, 0.05, and 0.01, respectively.
Chi-square and F values are given in parentheses.

p-value of 0.008. This result suggests that low-leveraged rms also 7.2. Sensitivity analysis
show relatively greater compliance with risk regulations, possibly be-
cause they wish to signal their nancing stability and their success in We compare the LMM main results with the models most fre-
managing their nancing risks. Underlying risk levels, therefore, do quently used in prior research, specically, OLS and FEM. The results
appear to inuence mandatory risk disclosures, albeit less signicantly of both models (not tabulated) lead to identical conclusions for both
than for aggregated and voluntary risk disclosures. Therefore, we accept aggregated and voluntary risk disclosures. However, the results for
H4 and reject the other hypotheses. mandatory risk disclosures differ slightly with each model. Further-
Firm size and dividend-yield are the only control variables of other more, we run the FEM regression for high- and low-risk rms for ag-
rm characteristics that inuence mandatory risk disclosures signi- gregated, voluntary and mandatory risk disclosures. The results (not
cantly and positively (at p-values of 0.000 and 0.002, respectively). tabulated) for aggregated, voluntary and mandatory risk disclosures
Thus, consistent with the predictions of signalling theory, large and give identical results for low-risk rms and very similar results for
high-dividend rms demonstrate greater compliance with mandatory high-risk rms. We also reconsider the earnings growth, rm size
risk disclosure requirements. These results, therefore, support Dobler's and variability of stock returns together as control variables because
(2008) argument that, even within highly regulated regimes, managers these variables are occasionally utilised as accounting indicators
have incentives to disclose more risk information. The compliance with of risk (e.g., Beaver et al., 1970; Brimble & Hodgson, 2007;
risk disclosure is likely to be signicantly and positively associated with Papadamou & Tzivinikos, 2012). Our results do not imply any signif-
board independence, as proxied by board size, and the proportion of ei- icant impact on our previous conclusions.
ther total non-executive directors or independent non-executive direc- Our results are analysed further to examine the extent to which our
tors, at p-values of 0.000, 0.023 and 0.100, respectively. Other corporate variables are endogenous. Omitted variables and simultaneity are the
governance characteristics (namely, CEO duality, CHS, NOSH_Factor, most frequent causes of endogeneity problem (Ebbes, Bockenholt, &
and Audit_Aggregated) do not inuence MRD. Wedel, 2004; Ebbes, Wedel, Bockenholt, & Steerneman, 2005). We ex-
amine these two issues by conducting an instrumental Two-Stage
7. Further analysis Least Squares (2SLS) regression to eliminate and assess whether there
are serious variations between the regressor variables and either the
7.1. High- and low-risk rms error term (omitted variables) or risk disclosures (simultaneity
problem).
We run the LMM for the same variables after discriminating be- We rst introduce the corporate governance variables as instrument
tween high- and low-risk rms. We implement beta to highlight such variables, and other variables are introduced as regressor variables. At
differentiation; if the rm beta is more (less) than one, the rm will the same time, we distinguish between market-risk measures (volatility
be classied as high- (low-) risk. of market returns, beta, volatility of standard error of CAPM and Sharpe
First, Table 3 indicates that the results for high-risk rms, with re- ratio) and accounting-risk measures (leverage and current ratio). Con-
spect to aggregated and voluntary risk disclosures, are the same as the sequently, we are able to observe any variations over risk disclosure, in-
LMM for the entire sample. Firm size, board size, independent non- cluding ARD, VRD and MRD (e.g., Antonakis, Bendahan, Jacquart, &
executive directors and NOSH_Factor inuence both aggregated and Lalive, 2012), and we are able to minimise the other possible drawbacks
voluntary disclosures signicantly and positively. Firms characterised of using instrumental variables (e.g., Ebbes, Wedel, & Bockenholt, 2009;
by high risk-adjusted returns, low liquidity risk, large boards of directors Larcker and Rusticus, 2010).
and a high percentage of independence of non-executive directors are Due to the effects associated with the incorrect identications of
likely to exhibit high compliance with risk disclosure regulations. Sec- these instrumental variables (Ebbes et al., 2005), we therefore statisti-
ond, the results for low-risk rms indicate that aggregated and volun- cally validate our instrumental variables and then detect whether or
tary risk disclosures are associated positively with unsystematic and not our data set exhibits endogeneity. Table 4 reports the results of
nancing risks. Mandatory risk disclosure is not associated with risk the validity of instruments using over-identifying restrictions (Sargan
levels but is inuenced by rm size signicantly and positively. and Basmann statistics) and the existence of simultaneity using Durbin,
In summary, our results indicate that high-risk rms are more Wu and Haumsan statistics. Sargan and Basmann statistics indicate that
likely to disclose both mandatory and voluntary risk information as the current instruments are valid and appropriate for use in the model.
a response to their risk levels than are low-risk rms. Durbin, Wu and Haumsan statistics all accept the exogeneity of market-

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
12 T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx

and accounting-risk measures with the risk disclosure. These results under this essentially voluntary regime, rms that fail to provide the
imply that there are no effects arising from endogeneity. levels of risk information expected by investors are likely to face conse-
quences in terms of increased cost of capital as a result of investors in-
8. Conclusions creasing their desired rate of return (Kothari et al., 2009). By revealing
risk information voluntarily, rms trust investors' and users' abilities
This study is the rst to investigate the main incentives for aggre- to modify and adjust any prior overestimations of discount rates. For in-
gated, voluntary and mandatory risk disclosures for a large sample of stance, all of the ICAEW's (1997, 1999, 2011) arguments assume that
UK all-share companies over an extended time period using automat- UK rms are motivated to disclose more voluntary risk information to
ed content analysis. The study is also innovative in employing the enhance their ability to obtain external funds at lower cost. Regulators
LMM to overcome the residual independence problem inherent in may wish to consider imposing additional mandatory requirements
the more common OLS or FEM. on UK rms to protect investors and to avoid negative effects that
We examine the extent to which rm risk levels (in terms of total, sys- may arise from non-disclosure.
tematic, unsystematic, nancing and liquidity risks, and risk-adjusted Second, within the UK and other major economies, most com-
returns) inuence risk disclosures. The results indicate that both aggre- ponents of annual report narratives and, in particular, those concerned
gated and voluntary risk disclosures are associated positively with sys- mainly with the disclosure of voluntary information are not currently
tematic and nancing risks and risk-adjusted returns. These results are the subject of external audit or assurance. Our research indicates that
consistent with both managers' incentive (agency and signalling) theo- a key element of such voluntary, unaudited information is that related
ries suggesting that managers are motivated to provide higher levels of to risk. Our results, therefore, reinforce existing work (e.g., Fraser et
risk information voluntarily to reduce information asymmetry; the re- al., 2010) suggesting that nancial statement users desire some element
sults are also consistent with prior empirical research (e.g., Abraham & of external assurance over annual report narratives or annual reports as
Cox, 2007). We nd that mandatory risk disclosures are inuenced a whole as well as that suggesting that auditors may be able and willing
more by other rms and corporate governance characteristics than by to provide such assurance (e.g., Fraser & Pierpoint, 2011).
rms' risk levels. Our research provides avenues for future research, and we suggest
The research has implications for the emphasis in the UK regulatory several examples here. First, within a UK context, an opportunity exists
regime (e.g., ASB; ICAEW) on encouraging and recommending risk to explore issues regarding investors' perceived risk (e.g., Linsmeier et
disclosures rather than on mandating them. Generally, UK rms appear al., 2002) or the information content of risk disclosures (e.g., Bajo,
to be motivated to provide appropriate risk information voluntarily as a 2010; Li, 2010; Ryan & Tafer, 2004). Second, previous research exam-
response to most underlying corporate risks (with the exception of high ines the readability of either general disclosures (e.g., Lehavy, Li, &
volatility of market returns). Merkley, 2011) or aggregated risk disclosures (e.g., Linsley & Lawrence,
Furthermore, our results have implications for users of annual re- 2007); future research might investigate the comparative readability of
ports. First, there is growing evidence acquired over a long time period mandatory and voluntary disclosures. Third, research is required on
(e.g. Beattie & Pratt, 2002; Fraser, Henry, Pierpoint, & Collins, 2010; the different incentives for risk disclosures existing internationally by
Weetman, Collins, & Davie, 1994) that investors now expect companies taking into account different national regimes, in terms of legal systems,
to provide relevant information in annual report narratives, including, cultural values, nance systems, ination and risk factors (e.g., Dobler,
for example, components of annual reports such as the Management Lajili, & Zeghal, 2011; Dong & Stettler, 2011). Fourth, it would be helpful
Commentary or Operating and Financial Review. Such information in- to establish whether users would value external assurance over risk dis-
cludes appropriate risk-related disclosures. Our research implies that, closures made in annual report narratives.

Appendix 1. Examples of risk statements and risk disclosure scores captured by Nudist 6

Firm name, ISIN code, and Sentence Risk disclosure scores in 2007
(year of annual report)
Aggregated Mandatory Voluntary

Arriva PLC, Foreign currency exchange risk: Derivatives are entered into in order to hedge exposure to foreign currency 266 18 248
GB0002303468, (2007) exchange risk.
Short term investment in nancial instruments is partially undertaken on behalf of the group by substantial
external fund managers who are limited to dealing in debt instruments and certain dened derivative
instruments and are given strict guidelines on credit, diversication and maturity proles.
British Airways PLC, Capital Investment: A wrong decision in respect of the Company's planned eet growth, in terms of timing, 345 39 306
GB0001290575, (2007) aircraft numbers or eet type, could have a material adverse impact on the group's future performance.
Foreign Currency Risk: The group generates a surplus in most of the currencies in which it does businesses.
Gains and losses on derivatives designated as cash ow hedges and assessed as effective for the period, are
taken to equity in accordance with the requirements of IAS 39.
BT Group PLC, New wave revenue in this segment increased by 24% to 677 million driven mainly by the 20% growth 719 95 624
GB0030913577, (2007) during the year in the number of BT Business Broadband customers to 579,000 at 31 March 2007.
Treasury Policy: The group has a centralised treasury operation whose primary role is to manage liquidity,
funding, investment and the group's nancial risk, including risk from volatility in currency and interest rates
and counterparty credit risk.
Bunzl PLC, The Company's operations are also subject to a variety of other risks and uncertainties relating to trading in 284 30 254
GB00B0744B38, (2007) numerous foreign countries, including the imposition of any import or investment restrictions, including
tariffs and import quotas or any restrictions on the repatriation of earnings and capital, and changes in tax
regulations and international tax treaties.
Sensitivity to interest rate risk: The group's prot is not sensitive to changes in the fair values of the interest
rate swaps and the intrinsic values of the interest rate collars since these achieve hedge accounting.
Davis Service Group PLC, The different service areas of our business offer different opportunities for growth and returns on our investment. 272 37 235
GB00B0F99717 (2007) We believe that attractive returns can be delivered from investment in bolt-on acquisitions where we can le-
verage our market leading position and scale to deliver higher levels of operational efciency to the acquisitions
that we have made.

This table provides examples of risk statements and the aggregated, mandatory, and voluntary disclosure scores captured by N6 based on risk word list, which were highlighted within the
context.

Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010
T. Elshandidy et al. / International Review of Financial Analysis xxx (2013) xxxxxx 13

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Please cite this article as: Elshandidy, T., et al., Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share
companies, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.07.010

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