**5. Hypothesis Development**

Dodd Frank Act of 2010 (DOF) was the United States Congress' response to the 2007–2009 global financial crisis primarily caused by a lack of proper risk assessment and managemen<sup>t</sup> (Dodd–Frank Wall Street Reform and Consumer Protection Act 2010). The DOF Act requires banks in n establishing either a risk and compliance board committee or a risk and compliance executive position. Prior research (e.g., Beasley et al. 2008; Aliabadi et al. 2013) argues that firms with financial challenges and high stock price volatility are more likely to adopt ERM in managing and disclosing their risks. Earlier empirical studies (e.g., Oliveira et al. 2011a, 2011b; Alsaeed 2006; Kamal Hassan 2009) that examined the relationship between the extent of disclosure and firm-specific attributes have shown that there are several firm characteristics that may influence the extent of disclosure in annual reports. Based upon theoretical discussion and previous empirical research on disclosure, we have selected six characteristics (firm size, financial performance, corporate financial leverage, liquidity, industry type, and auditor type) for this study to test their relationship with the extent of financial risk disclosure exclusively in the context of a developing country as there is hardly any empirical evidence on the same in literature.

### *5.1. Firm Size and Level of Financial Risk Disclosure*

Prior research (Linsley and Shrives 2006; Abraham and Cox 2007; Beretta and Bozzolan 2004; Hasan et al. 2008; Das et al. 2015) suggests that firm size is an important determinant of the level of disclosure and presents mixed results regarding the link between size and the extent of disclosure. Brammer and Pavelin (2008) argue that larger firms tend to be more visible to stakeholders as they tend to be more complex, and thus are subject to more inherent risk. Agency theory also suggests that larger companies have higher information asymmetry between managers and owners, and as such, higher agency costs arise. To reduce these agency costs, larger companies disclose more information than smaller companies. Political cost theory also supports this notion. We posit that larger firms provide more financial risk disclosure and formulate the following hypothesis:

### **H1.** *There is a positive association between the level of financial risk disclosure and firm size*.

### *5.2. Firm Performance and Level of Financial Risk Disclosure*

Prior research (Inchausti 1997) supports the existence of a relationship between company performance and risk disclosure in light of signaling theory. However, empirical results are mixed. Some studies (Wang et al. 2008; Nandi and Ghosh 2013) find a positive association, whereas other studies (Reverte 2009; Bujaki and McConomy 2002) report an insignificant relationship between firm performance and the extent of risk disclosure. However, studies (Hasan et al. 2008) in the context of Bangladesh find insignificant association between profitability and comprehensiveness of disclosure. Thus, we formulate the following hypothesis:

**H2.** *There is a positive association between the financial performance level of a company and financial risk disclosure level*.

### *5.3. Corporate Financial Leverage and Level of Financial Risk Disclosure*

The corporate financial leverage, as measured by total debt to total assets, may affect the level of financial risk disclosure. Companies with high levels of debt tend to be highly leveraged, more speculative, and riskier. Debt-holders have greater power over the financial structure of such companies. From an agency theory perspective, creditors of highly leveraged companies have strong incentives to encourage managemen<sup>t</sup> to disclose more information. Linsley and Shrives (2006) argue that firms with higher levels of risk disclosure provide greater amounts of risk-related information as managers are willing to explain the causes of high risk. Thus, we formulate the following hypothesis:

**H3.** *There is a positive association between corporate financial leverage and financial risk disclosure*.

### *5.4. Liquidity and Level of Financial Risk Disclosure*

Wallace and Naser (1995) argue that liquidity is an essential factor to disclose more information about a company's ability to meet its obligation, as well as to testify that the company is a going concern to dispel the fears of investors and creditors. According to signaling theory, a firm with a high liquidity ratio tends to disclose more information in order to be differentiated from other firms with a lower liquidity ratio. Conversely, agency theory proposes that firms with lower liquidity disclose more information to reduce conflict between shareholders and creditors. Findings of prior studies are mixed. For example, Naser et al. (2002) support this reasoning of agency theory, whereas other studies (Alsaeed 2006; Barako et al. 2006) do not support either of these two theories by reporting no association between liquidity and financial disclosure. These contradictory results provide an incentive to test this association between liquidity and disclosure. Thus, we formulate the following hypothesis:

**H4.** *The level of liquidity is associated with the extent of financial risk disclosure*.

### *5.5. Industry Type and Level of Financial Risk Disclosure*

The financial literacy level of capital market investors and participants is relatively low in Bangladesh, and thus in most cases, their source of information is only the audited annual reports of public companies, unlike in the United States with voluntary financial and non-financial information disseminated to the capital markets (e.g., managemen<sup>t</sup> discussion and analysis, short sellers, financial analysts, institutional investors). As stated earlier, high volatility and market manipulation is a common phenomenon in Bangladesh capital markets. Thus, a standardized risk reporting format is an urgen<sup>t</sup> requirement to achieve greater financial transparency and to make investors aware of the financial risks in this highly unpredictable environment. Homogeneous disclosure practices could be very helpful in this regard. Thus, the heterogeneous/varied financial risk disclosure practices of companies impedes obtaining an efficient capital market and informed assessment of the investors.

The industry type has been identified as a significant factor that influences the disclosure practices (Amran and Haniffa 2011). The signaling theory suggests a positive association between industry type and the level of risk disclosure. However, the prior empirical studies indicate mixed results, with some studies suggesting the association to be significant (Haniffa and Cooke 2002), whereas Naser et al. (2002) find an insignificant association between industry type and risk disclosure. Firms in the financial and chemical industries have more incentives to provide financial risk disclosure. Thus, we state the following hypothesis:

### **H5.** *The industry type is associated with the extent of financial risk disclosure*.

### *5.6. Auditor Type and Level of Financial Risk Disclosure*

It is reported that financial statements of firms that are audited by the Big 4 audit firms are perceived to be more credible than those audited by non-Big 4 firms (Das et al. 2015). These larger and well-known audit firms tend to encourage firms to disclose more information to safeguard the audit firms' reputation and avoid reputational costs to them (Chalmers and Godfrey 2004). Lopes and

Rodrigues (2007) find a positive relation between audit firm size and the extent of disclosure (Lopes and Rodrigues 2007). On the other hand, Deumes and Knechel (2008) report a negative association between auditor type and the extent of disclosure. The Big 4 international audit firms tend to operate in smaller capital markets through a local audit firm, and Bangladesh is one such setting where this unique alliance occurs (Kabir et al. 2011). Thus, we formulate the following hypothesis:

**H6.** *Audit firm size is associated with the extent of financial risk disclosure*.
