Predicting financial distress using textual risk disclosures in annual reports: How and what risks are disclosed?
Document Type
Research-Article
Journal Name
British Accounting Review
Keywords
Financial distress prediction, Textual analysis, Textual attributes, Textual risk disclosures, Topic model
Abstract
Textual risk disclosures in annual reports, which directly and foresightedly discuss firms’ potential risks negatively impacting their operations, are rarely considered in financial distress prediction. This study explores whether textual risk disclosures can provide valuable information to improve financial distress prediction accuracy. To comprehensively extract information from textual risk disclosures, textual attributes are utilized to capture “How” risks are disclosed, and a topic model is adopted to identify the textual topics to reveal “What” risks are disclosed. Based on textual risk disclosures from 48,224 annual reports of U.S. firms from 2006 to 2023, the empirical results demonstrate that incorporating risk disclosures improves predictive performance compared to the benchmark using numerical financial, market, corporate governance, and macroeconomic variables. Moreover, “What” risks are disclosed can offer more information than “How” risks are disclosed. Last but most importantly, as prediction horizon increases to a longer time, numerical variables show a significant decline in predictive ability, whereas textual risk disclosures can provide more helpful information and even improve prediction performance better. This study enlightens that investors and regulators should pay attention to textual risk disclosures in annual reports when assessing financial distress risks. © 2026