Risk factor disclosures tone and implied cost of equity

We examine the impact of the net positive tone of risk factor disclosures (RFD) on the implied cost of equity (COE). Using a sample of 18,172 observations from listed firms in the United States from 2006 to 2024, we find that net positive RFD tone is associated with lower COE. This finding is consistent with various robustness tests and accounting for endogeneity concerns. Our analysis further reveals that the net positive tone of financial category disclosures in RFD shows the highest effect on reducing COE, indicating that investors demand a lower uncertainty premium for a net positive tone of financial disclosures. We also document significant indirect effects of net positive RFD tone on COE through reducing investors’ uncertainty, proxied by cash flow volatility, information asymmetry, and stock return volatility. Finally, the analysis shows that the transparency of the firm’s information environment strengthens the effect of net positive RFD tone on COE. Overall, our article indicates that the tone of RFD is informative and shapes investors’ estimation of required return. JEL Classification: M41, G30, O16