More on Corporate Disasters and Stock Prices

Costa ConcordiaA few weeks ago, I asked whether financial markets systematically exaggerate legal risk to public companies stemming from high-profile corporate scandals. Today I continue the theme of that post by arguing that:

(1) if GM shares continue their impressive rebound, it would hardly be the first time in recent years, and

(2) depending on the industry, the effects can extend beyond the directly affected company’s stock and impact the sector of which it is a part.

(1) The GM share price recovery has at least one recent precedent. Remember the Costa Concordia disaster? The Carnival Cruise Lines-owned ship capsized off the coast of Italy on Friday, January 13, 2012, killing 32. The world was shocked at the ineptitude that caused the wreck, the rescue took longer than most would have expected, and the enormous capsized ship made for an unusual visual, dominating the news for a couple weeks.

At the time, in addition to talk about Carnival’s estimated non-insured losses, there was a lot of loose speculation that the disaster might constitute some sort of watershed for the cruise industry, consigning the likes of Carnival to secular decline due to a combination of litigation, regulation, and consumer fears.

Were these sentiments reflected in Carnival Corporation’s share price? Apparently some mix of them was, for a while. Here is Carnival stock (in blue) versus the S&P (red) for calendar year 2012. We see a sharp drop immediately following the disaster (at the left-hand side), followed by a recovery.

Overall performance for 2012 was nearly identical — +11.56% for Carnival versus +11.68% for the S&P. But that somewhat masks the likely impact of the disaster on prices.

Here is another comparison, from January 17, 2012 (the first full trading day after the disaster) to year end. Carnival’s stock performance is more than double the S&P’s over the same period:

Screen Shot 2014-06-19 at 6.05.49 PM

One could interpret this reflexively to mean that investors should simply buy the affected company’s stock or stock options when disasters seem to be at their worst. For a few reasons (some of which I discussed earlier), I think that’s reading too much into it. The chief problem is that by definition, the Moment of Peak Disaster Impact is only knowable in retrospect. Of course, one could try to measure the Peak General Time of Probable Disaster Impact, and draw conclusions on that basis, but that’s not what I’m doing here. I am asking a simpler question: do markets overreact to corporate disasters, particularly corporate disasters that imply a high degree of legal risk? And the evidence for that from Carnival (and to date GM) seems strong.

(2) Can the impact of a corporate disaster extend beyond the affected firm to its industry? 

The Costa Concordia event also gives us some evidence for our intuition that a disaster affecting one company can probably impact other companies in the same industry. Like Carnival, shares of Royal Caribbean Lines, a major rival, dropped significantly upon news of the disaster. Compare the stock price performance of Royal Caribbean (in blue) with Carnival (red), from the trading day following the disaster (January 17) through the end of 2012. Both bounce back strongly, but what’s remarkable is that by year-end shares for the two companies end up in almost the same place—Royal Caribbean is up 26.07% and Carnival 24.22%.

RCL v. CCL

RCL v. CCL

I have no special insight into what explains these precise movements. But given that both companies’ stock prices were negatively impacted by the Costa Concordia, this impressive recovery certainly is consistent with a theory that markets overreact to disasters—and that competitor firms can experience both collateral damage and a recovery that broadly tracks that of the directly affected firm.

Finally, firms in the consumer discretionary category (like cruise lines) are probably more susceptible to this kind of indirect shock than manufacturers of cars and other durables, because it’s easier for consumers to shift their spending to different modes of leisure than different modes of transportation. If you are shopping for a new car and you learn GM recently sold cars that were dangerous, you might buy a different brand of car, but you are unlikely to all of a sudden start taking the bus. On the other hand, if a disaster shocks you into thinking cruise ships are dangerous, you have many other vacation options.

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