Every year listed organizations must prepare reports outlining their financial situation and disclosures. They must raise significant concerns that are likely to influence the financial choices made by those who utilize financial statements, including as shareholders, investors, suppliers, management, and the government. The risk reporting disclosure is a component of these general disclosures, wherein an organization’s risks must be disclosed since all organizations are likely to encounter risks while achieving their goals. To evaluate how listed companies in England and Whales disclose risk and the reasons why they must do so better, this article will concentrate on their risk reporting. Prior to the conclusion, suggestions based on novel risk reporting principles have been made considering findings from the literature.

Introduction

Disclosure is the act of disclosing all pertinent information about a business that could influence an investment choice, according to Deumes (2008, p. 123). Organizations must adhere to all Securities and Exchange Commission disclosure standards in order to be listed on the Australian stock exchange. Both positive and negative information about the company must be included in order 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 need to make in order for stakeholders to understand how dangerous a company’s stock is for investments and other actions. Presenting risk disclosures serves to fairly depict the company’s risk situation so that interested parties can make informed decisions.

Seven sections make up this essay: the first covers information that companies disclose in their annual reports; the second discusses risk disclosure in annual reports; 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 entire essay.

Information Disclosed in Annual Report

Annual reports are released by companies to share information with their shareholders. Directors provide important information about the company’s operations and affairs using this channel. It might include a synopsis of the company’s goals and objectives. Furthermore, it includes details on the company’s goods and/or services.
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’ report, the period’s financial statements and 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. In the early days of corporate reporting, the annual report’s contents were limited to financial data, including specifics of the company’s financial choices made throughout the year. Furthermore, as stated in Arshad (2011), the criteria for annual reports have grown and now include a lot of the material specified in the previous paragraph. Furthermore, 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 choose a distinct head of risk, often known as the Chief Risk Officer, to analyze and appraise the risks the business faces. A supplementary report known as the risk review is prepared by the designated person and attached to the yearly report (Abdallah et al., 2015). 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 provided 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 company also influences how much risk is disclosed in the annual report, as stated in the Nur Probohudono (2013) 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, a number of research have found a negative correlation between a company’s risk disclosure and management level. One of the main determinants of the degree of disclosure is the ownership structure.

The independence of the board of directors dictates how many risk disclosures are required. According to Khan et al. (2013), there will be a high level of risk disclosures if the board is not independent and is instead employed by the corporation. 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.

Risk Assessment Methodologies

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 primarily two viewpoints about 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 beliefs, shareholders are one of the biggest parties involved in the disclosure requirement that managers must fulfill. Second, compared to other business sectors, the banking industry has the highest risk disclosure perspective. When distributing their lending, the banks assume enormous credit risks. According to the information asymmetry theory, one of the few theories of risk disclosure that Muzahem (2011) mentions, 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 top-notch auditors. According to some authors, there are justifications for managers to reveal risk information since doing so would reveal their risk management processes.
According to the signaling hypothesis, to draw in better investments, directors may choose to communicate risk information and convey profitability to investors. Finally, according to the political costs theory, businesses reveal risk information in order to avoid incurring political and contractual costs and the pressure that results from them.

Incentives/Disincentives to anticipate declaration

Businesses are required to make disclosures, but many are reluctant to do so because doing so 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 considered transparent if all necessary information has been revealed; however, businesses that do not provide 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. To maintain transparency, businesses are therefore urged to provide all relevant and mandatory information in their annual report. However, organizations with strong positions and reduced risk are particularly encouraged to give risk disclosure because there is no chance that stakeholders will make a decision that is detrimental to the company, according to 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 the risk position from the prior year, 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

Despite the numerous advantages of risk disclosure, organizations are reluctant to give their stakeholders a comprehensive view due to their potential negative impact on the business. Elzahar and Hussainey (2012, p. 135) assert that stakeholders will pull out of a company if it and its position are in jeopardy.

Since businesses aim to entice stakeholders with their annual reports rather than let them down, this 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 company discloses a lot of risk, it could jeopardize its standing on the stock exchange and see a decline in share price. Additionally, according to Said Mokhtar and Mellett (2013, p. 839), when a case is complex but crucial, it can occasionally be challenging for a business to measure risk appropriately. This complexity can also deter the business from reporting risk or raise investor withdrawal fears.

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. Risk assessment is crucial for organizations because it helps them understand where they are. They may make large profits, but they also run a high risk because of their capital structure or other problems. Vandemaele and Michiels (2009) claim that the ICAEW conducted groundbreaking research on the topic between 1997 and 2002, calling for a considerable improvement in risk reporting. Since then, both the quantity and quality of risk reporting have significantly increased. According to regulators, business risk extends beyond the possibility of company failure. Unexpected collapses may necessitate an emphasis on risk reporting quality and may heighten irrational expectations, such as the belief that risk reporting helps an organization 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 asserting that investors confront a variety of dangers while making investments and are prepared to accept these risks in exchange for greater profits, ICAEW has concentrated on the advantages of 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). Since most investors take risks in order to increase their profits, management shouldn’t fear that by disclosing risks, the company will alienate its investors. However, concealing risk from stakeholders will cause them to lose trust in you, and this is a more likely way to lose stakeholders because it fosters and maintains stakeholder trust, authorities urge businesses to disclose risk.

Risk appetite shouldn’t be driven by reporting requirements alone. Some executives may believe that anytime regulators and stakeholders want thorough and thorough risk reporting, they are requesting that organizations take on less risk. However, the robustness of the process that generates the risk, the quality of risk reporting, and the sensitivity of the company’s performance do not necessarily have to be correlated. 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 risks come in different levels and extents, and they may or may not be material. However, a ban organization must disclose any material risks that it believes could influence stakeholders’ decisions. Regulators, professional bodies, and stakeholders expect that organisations report what is happening internally and externally because risk reporting is beneficial for stakeholders and the company itself.

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. The ICAEW’s requirements for improvements included seven principles that could be used to improve risk reporting: telling users what they want to know, focusing on quantitative information, integrating into other disclosures, thinking beyond the annual reporting cycle, highlighting current concerns, reporting on risk experience, and having a short list of principle risks (Linsley and Shrives, 2006, p. 389).

To provide honest and trustworthy risk reporting, all companies listed on the English and Whale stock exchanges must adhere to these seven guidelines. External auditors question organizations and their executives about these disclosures even when there are no regulatory 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 risk assessment and decision-making, risk disclosure is made. Organizations must conduct risk assessments to develop policies that will reduce risk. A high level of risk indicates that the business is likely to experience a loss, which could lead to a decline in the share price and, eventually, the loss of the company’s market share and reputation. As a result, risk needs to be kept to a minimum, and authorities believe that properly reporting risk can help reduce it. The essay contains a section that determines the impact on risk disclosures. It has been discovered that risk disclosure in annual reports can be influenced by factors such as board independence, managerial ownership, firm size, and country.

According to this essay, stakeholder confidence is earned and maintained through appropriate risk reporting, which also discusses various viewpoints on risk and the incentives and disincentives that organizations face when disclosing risk. Nevertheless, the company’s fear of losing its risk-averse owners is a deterrent. Nonetheless, some risk-takers are prepared to invest in riskier companies. It should be mentioned that authorities are now placing greater emphasis on risk reporting since it has become essential for stakeholders and organizations alike. To make risk reporting clear and trustworthy so that stakeholders may trust such disclosures, organizations must adhere to the seven criteria listed in the previous section.

References

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