Downside Risk and Corporate Policies: A Text-Based Analysis

This paper develops a text-based risk measure using corporate annual reports and assesses its implications for corporate policies. Relative to return volatility, our risk measure captures downside possibilities evolving from firm fundamentals. We show that an increase in the text-based risk measure is followed by long-lasting diminishing leverage, investment, R&D, and employment, while the implications of increasing return volatility are insignificant. Dividends and cash holdings, however, display similar sensitivity to both risk measures. Our study highlights the limitation of market-based risk measures and helps explain why existing evidence on corporate policies is often inconsistent with corporate theory and field surveys.