Capital Markets

How to Damage Your Share Price

Research from a leading law firm reveals four kinds of company crises that can make a share price fall immediately or in the long term.
Andrew SawersDecember 11, 2012

According to international law firm Freshfields Bruckhaus Deringer, there are four main types of crises that can damage your share price. They don’t all have the same impact, whether short term or long. More to the point, however, how a company reacts to a crisis is a critical determinant of how bad the damage is. No surprise there, perhaps, but the deeper findings from research into 78 corporate crises that had reputational implications carry important lessons.

First, the four kinds of crises:

Behavioral. These relate to illegal or questionable conduct by employees, including bribery, corruption, money laundering, tax fraud, senior employee misconduct, and human rights violations.

Operational. Seriously affecting the company’s ability to function properly, these arise from environmental incidents, significant product recalls, accidents, natural disasters, and terrorism.

Corporate. Corporate crises include hostile takeover bids, changes in law, major litigation, tax or accounting issues, liquidity crises, or breaches of covenants.

Informational. Informational crises seriously affect IT infrastructure and include systems failures, hacking incidents, and loss of customer data.

Of the four types, operational crises are most likely to cause some damage to the share price in the first day or two, but that damage is relatively small. However, operational crises are more likely than the other types to have a long-lasting impact.

Behavioral crises (the report cites bribery and corruption problems at Willis Group and Aon) trigger the biggest day-one share-price fall. In fact, they are the only type that can instantly shave 50% or more off a company’s share price. Ironically, these big-hit crises also have the quickest recovery time, with almost all of the initial plunge recouped within six months.

Informational crises barely cause share prices to twitch, whether over the short or long term. Only 10% of companies hit by an informational crisis — such as Zurich UK’s loss of backup data in South Africa or the data hacking that leaked the information of 94 million TJX customers — saw their shares fall on the day of the announcement.

Corporate crises resolve most quickly, with only one company in seven still suffering a share-price hit six months on.

It is dangerous for companies to be complacent if the market’s initial reaction to a crisis isn’t too negative, Freshfields’s analysis shows. In fact, the impact on the market can be slow to start, but accelerate over time. For example, an operational crisis could take 7% off a company’s shares on day one, 13% within a month, 17% after six months, and 28% after a full year.

One broad conclusion from the analysis is that crises that are (in Freshfields’s lexicon) “intrinsic” to the company (emanating from something that is within a company’s control) have less impact over the short term but greater impact over the longer term than crises that are “extrinsic” (something unforeseen from outside the business, such as the expropriation of Repsol’s YPF assets by Argentina). “Unpredictable crises have the greatest upfront shock value,” the report says, “while problems that go to the heart of the company’s operations deliver a longer-term negative impact.”

There are two main lessons in crisis management to take from the report: first, a company can prepare in advance for crises, and a well-thought-out disaster-management policy will mitigate the damage. Second, don’t expect to be able to break the bad news yourself. In a news environment often driven by social media, the company may not even be the first to know, never mind the first to announce. But it’s important to make sure that the messages coming out of the company are accurate and consistent.

One more critical lesson: a crisis can damage more than just the share price. Of the 899 board directors in the companies analyzed as part of this research, 87 — almost 10% — left the company within six months of the crisis breaking. A little less than half admitted that the crisis was directly responsible for their departure, while at least some of the others probably left because of “a general board restructuring.” Moreover, at companies whose shares were still adversely affected six months after the start of a crisis, 15% of directors left the business.

Andrew Sawers is editor of CFO European Briefing, a CFO online publication.

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