Let's Talk About Risk! The Firm Value Effect of Risk Disclosure for European Energy Utilities

We analyse whether increased risk reporting by European energy utilities is positively or negatively related to firm value. Using an unsupervised machine learning topic model `Latent Dirichlet Allocation', we classify the content of the risk reports presented in the notes to the financial statements in different risk topics over the period from 2007 to 2017. We find that reporting market and credit risk as well as details of risk management and country-related risks is significantly related to higher firm values. The positive relation between risk disclosure and firm value is also robust for different levels of financial performance and the number of risk topics. Our study contributes to the call for more transparency in risk reporting and disclosure. Our findings imply that current risk disclosure regulation is useful in the sense that it provides information, which is reflected in the firm value. Interestingly, we are not able to identify a climate-related risk topic, and further tests show only rudimentary disclosure of climate-related risks. Combining the usefulness of the current risk disclosure regulation with the current lack of climate-related risk disclosures, we see good reasons for increased mandatory climate-related risk disclosures.