Undisclosed material inflation risk

Abstract

We identify many major U.S. corporations that are highly exposed to inflation risk. Yet, although the SEC legally requires disclosing possible risk factors, more than 61% of the inflation-exposed corporations do not disclose inflation risk. However, after being sued in a securities class action lawsuit, while all firms increase the length of their reported risk factor texts, only inflation-exposed firms are more likely to begin disclosing inflation risk. Simulations using calibrated parameters from our models reveal that 2%–6% inflation shocks over the subsequent three years result in market cap damages of $0.9 to $2.8 trillion for shareholders of inflation-exposed firms that never disclosed this risk. The inadequate inflation risk disclosure holds after allowing risk to be time varying, controlling for firm/industry characteristics, and/or exploiting a quasi-natural experiment that identifies causal effects and controls for possible unobservable factors. The evidence is consistent with corporate managers paying inadequate attention to inflation risk. Our framework enables identification and evaluation of stock price drop damages, especially for firms with inadequate risk disclosures, possibly improving disclosure practices, inflation expectations, and monetary policy transmission.