Corporate governance, risk disclosure, and stock returns in UK financial firms

Purpose: The purpose of this study is to fill a gap in the extant literature on risk disclosure by providing the first evidence on how corporate governance influences FTSE all-share financial firms to reveal risk disclosure. The paper further studies the extent to which the observed risk information affects stock returns. Design/methodology/approach: Using a sample period from 2005 to 2018 for UK FTSE all-share financial firms, this paper used automated textual analysis to capture risk disclosure in the narrative sections of annual reports. This paper’s findings are based on ordinary least squares (OLS) and fixed-effects estimations. Findings: Based on 1,800 firm-year observations, this study finds that UK financial firms with greater board independence, higher insider ownership and stronger audit quality are more likely to provide detailed risk disclosures in the narrative sections of their annual reports. In addition, we find that such risk disclosures positively and significantly influence the stock returns of these firms. The results are robust across various tests, including models capturing changes in disclosure practices, addressing endogeneity concerns and examining periods of financial instability such as the global financial crisis. Originality/value: To the best of the authors’ knowledge, this paper is the first to investigate how corporate governance influences FTSE all-share financial firms’ provision of risk disclosure in their annual reports. By linking governance, audit quality and ownership to improved disclosure practices, this study offers novel insights into transparency in UK financial firms. This paper also provides evidence to support the informativeness of the revealed risk information by UK financial firms through documenting the positive impact of risk disclosure on stock returns. It also highlights the importance of incorporating narrative risk disclosures into valuation models within UK financial firms.