Companies that mention hurricane damage in their 10-Ks see their stocks fall 5% in the following year
After striking Cuba on Tuesday with winds up to 125 miles per hour, Hurricane Ian is now a Category 4 storm as it approaches Florida’s west coast. Hurricane damage can be devastating and costly. But when it comes to corporations, research also links hurricane damage to a loss in market value.
Companies that reported hurricane-related financial damage to the U.S. Securities and Exchange Commission in their 10-K annual statements on average see their stocks fall 5% over and above the market in the following year, Deborah Pretty, founder of the risk analytics advisory firm Pentland Analytics, told me. This is based on research conducted by Pretty, on behalf of FM Global, and released in 2019, which Fortune reported on.
Do the research findings still hold true?
“Yes, I believe we are seeing an enduring change in the way markets react to companies experiencing climate-related loss and damage,” Pretty told me. “The research results were consistent across a large portfolio of companies, suggesting a systematic response by markets to disaster-struck companies. The results were very consistent also with a five-year global study of flood damage, suggesting that the impact on shareholder value from natural disasters is not special to hurricane damage.”
Pretty was commissioned by FM Global, a commercial mutual insurance and risk consulting company, to conduct research that expanded on the firm’s white paper, “Master the Disaster: Why CFOs Must Initiate Natural Catastrophe Preparedness in 2019 and Beyond.” FM Global identified big public companies that reported financial damage from the storm trio of Harvey, Irma, and Maria in their annual 10-K filings. In her research, Pretty used S&P 500 data to adjust for market forces including stock splits and dividends to isolate the impact on stock prices to get the specific impact on market capitalization. She then analyzed 52 U.S.-based large public companies. The companies collectively experienced a $18 billion loss of shareholder value for an average per-corporation loss of $346.2 million.
I asked Pretty how organizations can mitigate the effects of storm damage to their stock prices. “The evidence suggests that well-prepared companies do not just preserve their value but they add to their value,” she explains. “When disaster strikes, additional information about a company (and its management) becomes available to the market. Investors use this new information to reassess their expectations of future cash flow. When investors see what steps a company has taken to prevent loss and mitigate damage, expectations of future performance rise, as does the valuation.”
She continues, “The opposite is also true. When a company is shown to be unprepared for loss, investors de-rate their view of management and their ability to generate future cash flow, and the share price falls.”
When it comes to natural disasters, “it used to be the case that a market impact was only clear for those financial institutions who suffered a direct financial impact,” Pretty says. “For example, banks whose loan portfolios deteriorated and reinsurers who bore the brunt of the losses. Natural disasters were considered simply ‘bad luck’ for non-financial corporations.”
Pretty continues, “However, failure to prepare for natural disasters is now considered bad management. Investors are holding management of non-financial corporations accountable for what actions they took to protect the value of their assets against damage from climate-related events such as hurricanes and floods. Measures exist to prevent loss and mitigate damage, so if managers choose not to invest in them, the owners of companies (the investors) want to know why.”
What are some best practices in property protection to prepare for a hurricane? “To help minimize the effects of costly wind damage, organizations should have backup power generators ready, rooftops inspected and secured, doors braced, windows covered, and vulnerable objects put away or strapped down, including rooftop equipment and solar panels,” Pretty says.
As the current macroeconomic environment continues, many CFOs have stretched budgets. I asked Pretty if there are cost-effective ways of addressing natural disasters.
“Budgets are indeed under pressure, but the most cost-effective approach is for companies to focus on the long-term and recognize that prevention is better than a cure,” she says. “The cost of controls put in place to prevent loss or damage tend to be dwarfed by the cost to a business in damaged reputation, lost market share, and a strategic plan derailed by substantial loss. The evidence demonstrates that investing in physical resilience is value-adding in the long-term.”
See you tomorrow.
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