Wary investors hit by a natural disaster seek premium on equity investment
Changed behaviour by investors following a natural disaster can damage firms seeking to grow, new academic research suggests.
Investor caution soon after experiencing a natural disaster increases the cost of capital for businesses hoping to grow, new academic research suggests.
The study found that such investors consistently submitted lower bids for shares available through ‘seasoned equity offerings’ (SEOs) – a path often followed by listed companies to raise funds for investment and expansion.
Researchers analysed more than 41,000 bids from potential investors in Chinese SEOs between 2015 and 2023 – and mapped their location to a record of natural disasters, such as earthquakes and typhoons. The lower bids submitted by investors in those regions cut the level of new equity generated in the SEOs by around 4 per cent.
The paper, from Bayes Business School (formerly Cass), warns of the potential economic cost, saying that the impact of natural disasters on investors’ risk attitudes “goes beyond simply holding a bearish impact on stock prices”.
It concludes: “Our research has shown that natural disasters have real economic effects on both investors and the cost firms pay to raise equity capital. Clearly, this revelation carries implications for policymakers, corporations and investors.
“This suggests that disaster risk reduction and climate change mitigation are beneficial not only for our future environment but also for the functioning of the capital markets.”
Co-author, Dr Siyang Tian, Visiting Researcher at Bayes’ M&A Research Centre and Assistant Professor in Finance at the University of Sussex, said that institutional investors were affected almost as much as individuals.
He said: “This suggests that the impact and trauma of being touched by a natural disaster, which probably increases risk aversion, cannot be entirely offset – even for investors who are generally considered sophisticated. However, it was weaker for professionals who had some task-experience in SEO practice were less affected than their finance sector peers and in SEOs already seen as ‘riskier’.”
The paper suggests that three factors could contribute to the “plausibly causal evidence” of the “significant” link they identify. They are:
- Disasters can reduce personal wealth, making investors more cautious.
- Such experiences are emotionally powerful and memorable – leading investors to overestimate future risks.
- By heightening a sense of “background risk,” disasters make those affected generally more sensitive to uncertainty.
To test their hypothesis that heightened risk aversion following a natural disaster is most pronounced in people who were already highly risk-averse, the academics measured the impact in communities where Confucianism is influential. Risk aversion is a significant cultural value in Confucianism.
They found that the ‘natural disaster effect’ was particularly pronounced amongst investors in cities with high numbers of Confucian schools and where a high number of Jinshi degrees had been awarded during the Qing dynasty (1644-1912). Jinshi required a rich understanding of Confucian culture.
‘The paper, Does Natural Disaster Experience of Investors in the Primary Market Affect Cost of Equity Capital? Evidence from Seasoned Equity Offering Pricing’, is available in the Journal of Business Finance & Accounting.
