Connecting the Dots: Helping Investors Use Risk Disclosures When Evaluating Financial Statements

SYNOPSIS The SEC recently adopted a requirement for firms to provide a two-page summary of risk factor disclosures, intending to improve decision-usefulness for investors. This study evaluates the practical effectiveness of this requirement and an alternative proposal to enhance investors’ understanding: hyperlinking risk factor disclosures directly to related financial statement line items. Using experimental evidence from retail investors, we find that the SEC’s summarization requirement does not significantly influence investor judgments. However, our proposed hyperlinking approach significantly increases investor assessments of risk where appropriate, seemingly by improving investor acquisition and integration of relevant information in the risk disclosures. These findings question the efficacy of the SEC’s current summarization requirement as well as offer practitioners and policymakers a potential improvement for presenting risk disclosures. Implementing hyperlinks could enhance transparency and investor decision-making, aligning risk factor disclosures more closely with investors’ informational needs. Data Availability: Contact the authors. JEL Classifications: D81; G11; G41; M41.