Corporate risk communication as part of corporate governance – insights from a behavioral risk perspective

Abstract

When corporate ownership and control are separated, information asymmetries arise between the uniformed principal (investor) and the informed agent (manager). Within this principal agent conflict, the communication of risks faced by the entity is crucial within a corporate governance context, as investor decisions concerning a company are mainly driven by the evaluation of chances and especially of risks regarding the future prosperity of the company. Risks can thereby only be communicated reliably as part of corporate communication (i.e. without inducing unexpected behaviors), when the informational needs of the investors are understood. In order to derive insight about which variables are important in explaining how investors perceive risks disclosed by an entity, I develop a structural equation model in which I combine two theoretical approaches of human risk perception: the “decision theory view” and the “behavioral risk perspective”. For estimating the model, I make recourse to data derived from a survey that was conducted with 32 students who were asked to assess five risks which the fictitious “Alpha group” discloses in its management commentary. I chose the management commentary as the object of study, as it has a unique and increasing relevance as an instrument of capital market communication. My results suggest that both theoretical approaches are important in explaining investors´ risk perceptions. This finding calls into question that standard-setters predominantly adopt a decision theory view concerning risk reporting, and has further implications for the development of a company´s risk communication strategy within a corporate governance context.