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 1980s1990s2000s 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 Consulting Professional 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 ApproachBased upon work by: Risk SocietyBeck Cultural TheoryDouglas GovernmentalityFoucault PsychometricSlovic

Accounting & Risk Accounting Internal to a company Financial accountant Management accountant Internal auditor External to a company 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 Code ONLY 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 & company Encourages better risk management Cost of capital reduction

Why would directors disclose risk information voluntarily? Agency theory Jensen & Meckling (1976) Signalling theory Spence (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