Natural disasters and man-made crises are on the increase and range from climatic catastrophes, such as earthquakes and hurricanes, to human-induced crises, such as corruption and other scandals. These disasters have a significant impact on financial markets, since they affect shareholder value depending on the type and magnitude of a disaster. According to Knight and Pretty (1996, p. 3), the impact of catastrophes on shareholder value is quite complex, since it depends on the type of catastrophe, and how the management deals with the crisis. Therefore, the effect of catastrophes on shareholder value may be either positive or negative, depending on an immediate economic effect and management recovery style (Knight & Pretty 1996).
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The main theme of this study will be to identify the impacts of catastrophes on financial markets, the recovery strategies used by companies facing a catastrophe, and other factors that influence the recovery process of a company from a crisis. Before embarking on, it is vital to understand what shareholder value is. According to Ross (2008, p. 1), this term can be used to refer to the value of company’s stocks (how much company’s stocks are worth), the long-term value of firm’s assets, and the total value of the firm after deducting debts. Generally, stockholder value stands for the total value that the company is worth after calculating all expenses. Another terms, which are worth understanding, are “catastrophe”, “disaster” and “crisis” used as business terms. These refer to any problem that affects the continuity of business operations and ranges from natural disasters, such as earthquakes, typhoons, hurricanes and storms, to anthropological crises, such as scandals. For instance, the airline industry faces such crises as aircraft crushes, whereas the chemical industry faces the risks of chemical spills. Other crises affecting businesses include sex scandals, corruption and fraud cases. All the aforementioned issues affect company’s shareholder value.
Several studies were conducted in the past to determine the impact of crises on company’s shareholder value. The study by Ross (2008) shows that the effect of disasters on shareholder value is three-fold, meaning that the value can increase, drop or remain the same, depending on the type and impact of crises, as well as the recovery strategies used by the management. However, at the initial stages, when a disaster strikes, the value of stocks drops and stays negative for almost fifty business days (Ross 2008).
Another research conducted by Knight and Pretty (1996) is in agreement with Ross’s findings, stating that the effect of catastrophes on shareholder value may be either positive or negative. Their study puts forth that there are two broad types of factors, which determine the impact of crises on stock value. The first type of factors includes the financial effects of a catastrophe, whereas the second one is indirect influences manifested through the response of the management to the disaster (Knight & Pretty 1996). Moreover, Knight and Pretty acknowledge that, in most cases, the financial implications of a disaster affect shareholder value negatively, especially at the initial stages. This concurs with Ross’s conclusions that a crisis negatively affects stock value in the immediate aftermath, but the recovery process depends on the leadership of the company. Furthermore, Knight and Pretty (1996, p. 6) identified two groups of firms: recoverers and non-recoverers. The former group manifests an effective leadership style, whereby the effects of disasters are dealt with in a strategic manner, attracting more investors and in turn increasing shareholder value (Knight & Pretty 1996). On the contrary, non-recoverers manifest poor disaster recovery strategies, such as hiding the causes of the crisis and the lack of communication to key stakeholders, such as employees, and as a result worsening the effects of the disaster.
The report by Ernst and Young (2002) shows that a crisis has both positive and negative impacts on share pricing, but the recovery process depends on the way management deals with the crisis in the process of recovery. Relying on this report, it is clear that recoverers work towards share price recovery, where leaders and investors make it a priority to stabilize share value (Ernst & Young 2002). This report also classifies risks into three classes, namely financial, operational and strategic, which affect share value (Ernst & Young 2002).
The recent study by Thomann (2012) shows that catastrophes are important in insurance businesses, since catastrophic events increase the volatility of insurance stocks. The occurrence of catastrophic events encourages more people and businesses to insure their property. As a result, it increases the returns of insurance stocks. This means that disasters present an opportunity for insurance businesses to grow. However, the question that comes up is “Will insurance companies gain much from insuring property against disasters?”
The bottom line in the previous research work is that the company’s recovery process from a crisis is determined by the leadership style of the management. The leadership behavior is the key determinant of the effects of a crisis on stock value. Blythe (n.d., p. 6) acknowledges that crisis planning and management should be an ongoing process as opposed to a short-term project that most managers tend to embark on. Garcia (2006, p. 4) voices out a similar opinion to that one of Blythe that effective crisis management is crucial, since it puts a company at a competitive advantage over its rivals. Garcia (2006, p. 5) further suggests that during a crisis, the management should put aside normal business operations and decision-making processes, and revert to the crisis management plan in order to ensure that stakeholders’ interests are protected. Garcia gives the example of McDonald’s decision to adopt healthy and less fatty foods, such as salads, after its CEO died of a heart attack in 2004. This catastrophic event showcases the importance of effective management during a crisis. The management’s decision did not only increase shareholder value, but also improved the overall image of the brand by portraying it as a company that cared about the welfare of the society. Garcia (2006, p. 8) concludes by saying that those leaders, who are effective in their leadership style, direct their energy towards a quick response to a crisis in order to protect the value of the company.
Furthermore, the study by Handfield (2007, p. 35) shows that an effective response to a crisis includes the development and implementation of intervention strategies that reduce negative impacts of the crisis, while at the same time amplifying positive ones. The management should be able to adopt strategies that ensure early detection of risks and back-up resources for necessitating short-term recovery processes. Additionally, an effective leadership behavior ensures that sustainable (long-term) approaches for eliminating the risks of crises in the future are put in place in order to reduce the impacts of disasters on company’s enterprise value.
There are some other factors, apart from the leadership behavior, that affect the recovery process of the company after a crisis. Such political factors as policies and regulations laid down by governments affect the recovery process of the company, since some policies may require the restructuring of company processes. Additionally, these policies may impose extra expenses on the company slowing down the recovery process. Another factor that can influence this process is the commitment of all other stakeholders, such as employees, to the recovery process. Dedicated employees will ensure that this process is fast, and that effective preventive measures are enacted.