Using relevant headings in risk factor disclosures: What is the impact on information processing?

This paper empirically examines whether using relevant headings to categorize risk factors in Item 1A of Form 10-K can enhance its readability and thus facilitate investors’ understanding. Using a sample of S&P 1500 firms from 2017 to 2019, we find that post-filing abnormal returns and abnormal bid–ask spreads are lower for firms that use headings in Item 1A than for those that do not. We also find that these associations are stronger when filings have low readability, when the firm has higher financial risk, and when there is higher content concentration in risk factors under the same heading. Given that Regulation S-K was amended in 2020 to mandate categorizing risk factors under relevant headings, our findings provide policy implications by showing that such categorization helps investors to navigate risk factor disclosures and, thus, improves their process of comprehending information.