ANNUAL REPORT-BASED RISK DISCLOSURE PRACTICES

Listed Globally, companies must prepare yearly reports outlining their financial status and disclosures. These reports must include significant issues that could influence the economic choices of those who use financial statements, such as shareholders, investors, suppliers, management, and the government.
The risk reporting disclosure is a component of these general disclosures, whereby an organization’s risks must be disclosed since all organizations are likely to encounter risks while achieving their goals. This essay aims to evaluate how listed companies in England and Whales disclose risk, as well as why and how they need to improve their risk reporting. Before the conclusion, suggestions based on new risk reporting standards have been made considering the literature’s findings.

Introduction

According to Dems (2008, p. 123), disclosure is the act of making available all pertinent information about a business that could influence an investment choice. Organizations must adhere to all disclosure criteria set forth by the Securities and Exchange Commission to be listed on the Australian stock exchange. Both positive and negative information about the company must be included to give a realistic picture of its financial situation. Disclosure items cover a wide range of topics, including the company’s operating performance, financial health, management compensation, and risk disclosures. This essay focuses on the risk disclosures that businesses must make for stakeholders to understand how dangerous a company’s stock is for investments and other choices. Presenting risk disclosures serves to fairly depict the company’s risk situation so that interested parties can make informed decisions. Seven sections make up the essay: the first covers information that companies disclose in their annual reports; the second discusses risk disclosure in the annual report; the third discusses various risk perspectives; the fourth discusses incentives and disincentives to disclose; the fifth explains why regulators support risk disclosure; the sixth offers suggestions to companies regarding their risk disclosures; and the final section concludes the essay.

Information Disclosed in Annual Report

Annual reports are released by companies to share information with their shareholders. Directors provide important details about the business’s activities and affairs using this channel. It might include a synopsis of the company’s goals and objectives. Second, it includes details on the goods and services the business provides. The report mentions recent developments. The strategies, the chairman’s or CEO’s communication, the financial review and other business data, the risk assessment and corporate governance requirements, the directors’ reports, the period’s financial statements, the auditors’ report, and other supporting documentation are all displayed. According to research on annual report disclosure, shareholders and potential shareholders consult the report while making decisions. When corporate reporting first started, the annual report only included financial data, along with specifics on the company’s financial choices made throughout the year. Furthermore, as stated in the preceding paragraph, the standards for annual reports have grown and now include a lot of material, according to Arshad (2011) and businesses also offer sustainability and environmental reports. These days, the annual report includes a risk review as a crucial component. It describes the different risks that the business faces and the steps taken to mitigate them. Information regarding the company’s business risks is of relevance to the shareholders and potential shareholders.

Risk disclosure in annual reports

Businesses choosea distinct head of risk, commonly known as the Chief Risk Officer, to analyze and appraise the risks the business faces. According to Abdallah et al. (2015), the designated individual creates a separate report known as the risk review and attaches it to the yearly report. According to Arshad’s (2011) essay, risk disclosure is the sharing of strategic information along with other operational and external information that affects the company’s development.

Typically, the information is essential for the shareholders’ decision-making process. It falls into two categories: required information and optional information. According to the publication, readers of the annual report prefer non-mandatory information when making financial decisions and determining their level of risk. The jurisdiction in which the firm operates, the size of the company, management ownership, and the independence of the board of directors are some of the elements that influence risk disclosure in annual reports.

According to Nur Probohudono (2013), the rules that apply in the nation have an impact on the disclosure requirements since they specify the scope of voluntary disclosure that must be made. The author goes on to say that because of the varied regulatory contexts, regulations created in the United States and the United Kingdom have different implications. This indicates that a significant determinant of the extent of risk disclosures is the country. Second, the size of the business also influences how much risk is disclosed in the annual report, as Nur Probohudono (2013) noted in the article.

The size of the company determines the voluntary disclosure. The amount of voluntary risk disclosure is also influenced by the company’s listing status. It is also mentioned that larger organizations have more duties. Elshandidy et al. also remark the same thing (2013). The degree of managerial ownership is another element that is discussed in the same article. There is less risk disclosure and fewer opportunities for risk-related disclosure to be communicated in an organization with greater levels of hierarchy.

According to the article, several research have found a negative correlation between risk disclosure and the company’s management level. One of the main determinants of the degree of disclosure is the ownership structure. Finally, the amount of risk disclosures that must be provided is determined by the independence of the board of directors. According to Khan et al. (2013), there will be a high level of risk discloures if the board is not independent and is instead employed by the business. Disclosure must be made voluntarily. Independent directors on the boards prioritize more optional information in the annual report, according to the studies cited in Nur Probohudono’s (2013) essay.

Different risk perspectives

None of the relevant accounting rules in the UK place any emphasis on risk reporting. Therefore, none of the regulations enforce the mandatory requirements of risk disclosure. The ICAEW requires certain voluntary disclosures, as stated in the Elshandidy (2013) article. According to Klumpes et al. (2017), there are two viewpoints on the voluntary disclosure of risk information to stakeholders. When the managers receive good news regarding the disclosure, they usually share the risk information if the cost-benefit analysis shows that it is advantageous. The public’s need for greater openness is the cause of the increased information disclosure. Bigger companies are better positioned to reveal information. According to the aforementioned beliefs, managers must satisfy shareholders, who are among the biggest stakeholders in the disclosure obligation.

Second, compared to other business sectors, the banking industry has a stronger focus on risk disclosure. When distributing their financing, the banks assume enormous credit risks. According to Muzahem (2011), there are a few ideas on risk disclosure. One of these, known as the information asymmetry theory, claims that risk disclosure is very beneficial to analysts, investors, and other corporate stakeholders.This sharing lessens information asymmetry and encourages transparency. Agency theory, on the other hand, recommends that pertinent information be revealed, assisting investors in making sure that contracts are being followed. Under pressure from shareholders, the managers reveal the risk information.

To ensure that accurate information is included in the yearly report, they select auditors of the highest calibre. According to some authors, there are justifications for managers to reveal risk information since doing so would reveal their risk management processes. The signalling theory highlights that directors may wish to communicate the profitability of investors by revealing risk information to draw in stronger investments. The political costs argument, which comes last, states that businesses reveal risk information in order to avoid incurring contractual and political expenses and pressure.

Incentives/disincentives to provide disclosures

Despite being compelled to make disclosures, businesses are reluctant to do so because presenting risk disclosures has disadvantages. They might, after all, work against the corporation. This essay section discusses the incentives that push businesses to disclose risks and the barriers that prevent them from doing so. The benefits and drawbacks of including risk disclosures in the annual report are as follows:

Incentives

According to Dobler (2008, p.186), a firm and its operations are transparent if it has revealed all the information that is required of it; yet, businesses that do not give full disclosures may be viewed with suspicion. Stakeholders may believe that the company’s risk position is poor, which is why it hasn’t revealed the facts to prevent them from making a choice against it. Companies are therefore urged to include all relevant and necessary information in their annual report in order to guarantee transparency.

However, firms with a strong position and reduced risk are particularly motivated to disclose risk because there is no chance that stakeholders may choose to oppose the company, claim Woods and Humphrey (2008, p. 47). Furthermore, transparency increases the value of the company’s shares, strengthening its position on the stock exchange. Furthermore, businesses are trusted by independent auditors because they believe that they appropriately report what they are obligated to report, negating the need for in-depth examination.

Additionally, risk disclosure gives management the ability to examine its risk position critically and determine if it has improved or deteriorated by comparing it to that of prior years. Which it can use to create and carry out pertinent policies. Whales and listed companies in England must adhere to the ICAEW’s rules, which call for detailed risk disclosures in order to provide stakeholders with transparent information. Companies are encouraged to disclose risk disclosure under this ICAEW regulation.

Disincentives

Even though there are many advantages to sharing risk, organizations are reluctant to give their stakeholders their full position because of their potentially detrimental decisions. Elzahar and Hussainey (2012, p. 135) assert that stakeholders will pull out of a company if it and its position are in jeopardy. Because businesses want to entice stakeholders with their annual reports rather than let them down, it is the most prevalent deterrent for risk disclosures.

Any stakeholder will seek out any good news and would rather put money into a business that poses less risk. Attracting stakeholders for a listed company’s benefit is one of its main objectives. Stakeholders, however, are interested in their own gain and would rather invest in a less risky enterprise. Furthermore, if a corporation discloses high-risk information, it could jeopardize its standing on the stock exchange and see a decline in share price. Moreover, Said Mokhtar and Mellett (2013, p.839) noted that it can occasionally be challenging for a business to accurately assess risk when it is complex but crucial.This kind of difficulty could also deter the business from disclosing risk or the concern that investors will get out.

The reason why regulators encourage risk disclosure

According to Ryan (2012, p. 297), the regulators’ decision-making and risk assessment are the two primary goals of risk disclosures. All parties involved in the business, including management, are involved in this decision-making process. The process of risk assessment is crucial for organizations because it helps them realize where they are. They may make a lot of money, but they also run a significant risk because of their capital structure or other problems. Vandemaele and Michiels (2009) state that ICAEW conducted groundbreaking research on the topic of risk reporting from 1997 to 2002. It stated that there should be a major improvement in risk reporting. Both the quantity and quality of risk reporting have significantly increased since then.

According to regulators, business risk extends beyond the possibility of company failure. Unexpected collapses could occur, which would unavoidably need an emphasis on risk reporting and could heighten irrational expectations. For example, risk reporting helps organizations avoid future failures. There is no assurance that risk reporting alone will give accurate early notice of any failure. However, there is always a chance that an organization will fall short of its goals, which is why risk reporting is essential. By pointing out that investors encounter a variety of dangers when making investments and are prepared to accept these risks in exchange for greater returns, ICAEW has concentrated on the advantages for investors. They should be aware of all organizational uncertainty since they have a stake in the business and are willing to take these risks.They lose their money and can stop trusting the company if a significant danger is not mentioned to them. It suggests that failing to disclose risk may have negative effects on the organization, investors, and other stakeholders. Investors take into account business risk to the extent that they are aware of it, according to Rajab and Handley-Schachler (2009, p. 226).

The majority of investors aim for greater profits by taking risks. Management shouldn’t believe that by disclosing risks, the company will alienate its investors. However, failing to disclose risk to stakeholders will lead to a loss of their trust, and this is a more likely course of action.That is why regulators aids in gaining and maintaining stakeholder trust, authorities encourage businesses to disclose risk. Regulators consider risk reporting to be a result of a company’s risk appetite, which is established by the amount and type of major hazards it faces and the risks it is willing to take in order to accomplish organizational goals (Hill and Short, 2009, p. 755).

Risk appetite shouldn’t be influenced by reporting requirements alone. When stakeholders and regulators request thorough and thorough risk reporting, some CEOs may believe that they are requesting that organizations reduce their risk-taking. However, the robustness of the process that generates the risk and the sensitivity of the company’s performance do not necessarily have to be correlated with the quality of risk reporting. It demonstrates how important it is for businesses to report hazards, and authorities even claim that it encourages businesses to take fewer risks.

Recommendations

Due to ICAEW’s increasing criteria for risk reporting and its insistence that businesses disclose risk in a transparent manner, risk reporting has recently gained attention from organizations (Elshandidy and Hussainey, 2013, p.323). This ICAEW consideration suggests that risk reporting is a critical issue for businesses and their stakeholders.

According to ICAEW, risk assessment and decision-making are the two main goals of risk reporting. Since there is always some risk involved in accomplishing organizational goals, a business must evaluate its risk position. These dangers come in different levels and extents, and they might or might not be significant. Nonetheless, any significant hazards that a ban organization believes could influence stakeholders’ choices must be disclosed. Because risk reporting benefits stakeholders and the business itself, regulators, professional associations, and stakeholders expect organizations to report on internal and external events.

According to authorities, risk is reduced when a firm declares its risk position accurately, and the current mandate to increase risk reporting calls for enterprises to be even more transparent in presenting their risk position. Consequently, it is advised that all businesses listed on the Whales and England stock exchanges provide suitable risk disclosures. Seven concepts that could be used to improve risk reporting were among the changes mandated by ICAEW.

According to Linsley and Shrives (2006), p. 389, these include: the company should ask users what they want to know; it should concentrate on quantitative information; it should integrate into other disclosures; management should think beyond the annual reporting cycle; the list of principal risks should be brief; current concerns should be highlighted; and it should report on risk experience. These seven guidelines must be adhered to by all companies listed on the English and Whale stock exchanges in order to ensure that their risk reporting is trustworthy and transparent. External auditors question companies and their executives about these disclosures even when there are no legal requirements; now that regulations oblige corporations to improve these disclosures, auditors will be much more careful. When making disclosures, it is advised that all publicly traded companies take these seven new guidelines into account.

Conclusion

This essay discusses risk disclosures and the existing regulations and professional associations, such as ICAEW, that mandate them. The article emphasizes the significance of risk disclosures for the business and its stakeholders by claiming that the annual report and its components of which risk disclosure is a crucial part are the basis upon which stakeholders make their financing decisions.

For the purpose of risk assessment and decision-making, risk disclosure is made. Organizations must conduct risk assessments in order for management to create policies that will reduce risk. A high amount of risk indicates that the business is likely to experience a loss, which will lower its share price and eventually cause it to lose its market share and reputation. As a result, risk needs to be kept to a minimum, and regulators think that properly reporting risk can help reduce it. The impact on risk disclosures is assessed in a portion of the essay. Risk disclosure in annual reports has been found to be influenced by a number of factors, including board independence, managerial ownership, firm size, and country. Stakeholder confidence is earned and maintained through appropriate risk reporting, according to this essay, which also discusses various viewpoints on risk and the incentives and disincentives for organizations to disclose risk. The company’s fear of losing its stakeholders who aren’t willing to take chances is still a deterrent.

Nonetheless, some risk-takers are prepared to put money into businesses that pose greater dangers. It should be mentioned that authorities are now placing greater emphasis on risk reporting since it is now essential for stakeholders and organizations alike. For risk reporting to be open and trustworthy and for stakeholders to be able to rely on such disclosures, organizations must adhere to the seven principles listed in the previous section.

References

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