Professor Philip Linsley The University of York

Three sessions Monday Should companies report on risk in their annual report? Tuesday Short history of risk and risk management Wednesday Why is it difficult to create a risk management system that works?

Should companies report on risk in their annual reports?

An introduction to the issue of risk disclosure The development of the idea of risk disclosure Problems in risk disclosure

Risk & Business Every business involves risk BUT INVESTORS & STAKEHOLDERS HAVE LIMITED KNOWLEDGE OF THE RISKS

OVERALL NEED FOR COHERENT VIEW OF RISK SUGGESTED IN LATE 1990s OVERALL NEED FOR COHERENT VIEW OF RISK Companies should report on overall risk position 1. List the major risks 2. Describe actions taken to manage those risks 3. Identify the size of the risks

FOOD AND CLOTHING COMPANY REVENUE £10bn Lists 12 major risks in 2017 annual report

RISK DESCRIPTION OF RISK MANAGEMENT OF RISK Market competition Future performance will be impacted if we fail to meet customer expectations Strategy in place to improve profitability Focus on product quality and style Engaging with customers ….

DIRECTORS IGNORED THE SUGGESTION IT WAS THEN SUGGESTED IN EARLY 2000s 1. Disclose forward-looking (future) risk information 2. But exclude commercially sensitive risk information 3. And disclose voluntarily (no regulation)

Why future risk information? Better than past risk information But predicting the future is difficult And predicting the future could be problematic Inherent uncertainty and shareholder reliance on the information

Why allow commercially sensitive information to be excluded? To encourage directors But this is problematic

Why make risk disclosure voluntary? Directors have incentives Demonstrate accountability Demonstrate equal treatment of all shareholders Signal strategic capabilities Lower cost of capital

Risk disclosure requirements have now arisen in many different countries

But note that banks have very different requirements UK Law now requires description of principal risks and uncertainties in annual report But note that banks have very different requirements

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

ITEM 1A.  RISK FACTORS If we do not anticipate and address evolving consumer preferences, our business could suffer. Increased competition and capabilities in the marketplace could hurt our business.

ITEM 1A.  RISK FACTORS Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, may reduce demand for our beverage products.

ITEM 1A.  RISK FACTORS Raw materials supplies The citrus industry is subject to disease and the variability of weather conditions, which affect the supply of orange juice, an important raw material for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice. In addition, disease is reducing the number of trees and increasing costs. Adverse weather conditions may affect the supply of other agricultural products we use. For example, drought conditions in certain parts of the United States may negatively affect the supply of corn.

Academic studies Beretta, S. and Bozzolan, S. (2004). A framework for the analysis of firm risk communication. The International Journal of Accounting, 39, 265-288. Maffei, M., Aria, M., Fiondella, C., Spanò, R., Zagaria, C. (2014). (Un)useful risk disclosure: explanations from the Italian banks. Managerial Auditing Journal, 29(7), 621 – 648.

Does this mean risk disclosures are not useful? Perhaps they serve the purpose of reassurance?