Analyzing the Effects of Topics Underlying Companies' Financial Disclosures about Risk Factors on Prediction of ESG Risk Ratings: Emphasis on BERTopic

The contribution of ESG (environmental, social, and governance) risk ratings to investor interest is growing in significance. Numerous investors use ESG risk ratings as a crucial criterion for investing in particular companies and/or industries. Despite this, there are few studies on the topics underlying companies' financial disclosures about their performance and risk factors that may have a significant impact on the prediction of ESG risk ratings. We examined text information from Item 1A risk factors in the SEC EDGAR 10-K collection for 1,663 S&P 500 companies from 2016 to 2020. BERTopic was used to conduct topic modeling. Contrary to our expectations, our findings indicate that text-based topics reduced the model's ability to accurately predict ESG risk ratings over the entire sample period. After 2019, the performance of the proposed model with a number of topics extracted from the dataset improved, and it is possible to conclude that ESG risk ratings are crucial for both investors and businesses.