Material inflation risks or: why a US listing may be riskier than you think

In every developed country I know, companies are required as part of their reporting obligations to disclose material risks to their business and how they manage these risks. If you read through them, you will invariably get the impression that these disclosures are just boiler plate disclosures written by a couple of lawyers to cover the backside of the company. But apparently, one material risk factor has been subject to (benign) neglect for many years: inflation.

Obviously, inflation has not been an issue for decades and thus, corporate executives and risk managers weren’t really accustomed to thinking about inflation as a major risk factor. Thus, it comes as no surprise that when Yaniv Konchitchki and Jin Xie checked the material risk disclosures of US companies the results were all over the place.

They looked at companies’ material risk disclosures in 10-K forms filed with the SEC and compared these disclosures with the average share price reaction to unexpected inflation. If the share price reaction to unexpected inflation was negative and statistically significant, the company was considered materially exposed to inflation risks. If the reaction was not statistically significant, it was not considered materially exposed.

The chart below shows that only about 13.8% of all the companies in the US are materially exposed to inflation risk, but out of these, only one in five actually mention inflation as a material risk to investors. In fact, the same one in five ratio can be found among companies not materially exposed to inflation risks but choosing to mention inflation as a material risk. In other words, whether a company discloses inflation as a material risk or not is largely random.

Inflation risk exposure and disclosure practices

Source: Konchitchki and Xie (2023).

I don’t blame any company for not mentioning inflation as a material risk factor in the past, but if you want to know why companies should not get a US listing, think about this. The US is a more litigious country than others and the lack of disclosure opens up companies to class action lawsuits. In fact, the study by Konchitchki and Xie found not only that such class action lawsuits have happened in the past, but that companies that are targeted by such lawsuits tend to increase the discussion about inflation in their earnings calls and include inflation as a material risk factor in their 10-K.

Now, I think such lawsuits are frivolous. I was taught to take responsibilities for my actions and that means that if you lose money in an investment, that is your responsibility and you don’t run to a lawyer to sue everyone you can think of to get your money back. But alas, some people may think they are entitled to stocks as a riskless investment and they may decide to pursue the legal route to be compensated for the losses they made in 2022. And while that is unlikely to work outside the US, it may well work there. Which is why I think the many European companies that are thinking about listing their shares in the US rather than in “boring” and “overregulated” UK and Eurozone may expose themselves to some material and unwanted risks.