Terrorist attacks and mass shootings can affect company accounting

Businesses tend to become more cautious in their financial reporting in the aftermath of a terrorist attack or mass shooting, according to a recent study.

The study, which appeared in the British Accounting Review, found the negative effects of terrorist attacks and mass shootings can lead to pessimistic risk assessments of financial reporting choices and a decline in accrual-based and real earnings management for companies located in the impacted areas. 

“My research found that after major events like terrorist attacks, company managers often become more cautious,” said Seda Oz, an assistant professor of accounting at the University of Waterloo in Canada, who wrote the study. “They start to think that negative events are more likely to happen, even if that’s not the case. As a result, they are less likely to use creative accounting practices to make their company’s financial performance look better than it is.”

She examined over 47,000 yearly reports from more than 5,600 companies and 716 major attacks in the U.S. between 2000 and 2020. The study used data from sources such as the Global Terrorism Database and Mother Jones, along with corporate data from databases like Compustat and EDGAR. The research found that companies close to where such events occurred were less likely to “massage” their financial figures and were more straightforward in their financial reporting. The impact was especially noticeable in companies that typically don’t share much information with the public and those with more cautious annual reports.

Oz believes such reporting changes could represent a crucial factor in predicting a company’s future performance and investment risk, and policymakers may want to consider introducing mandatory stress tests or enhanced disclosure requirements for businesses in regions experiencing a terrorist attack to help maintain market stability and investor confidence.

The paper studies the role of availability heuristics — a kind of cognitive bias that helps individuals make quick, but sometimes incorrect, assessments — within the realm of earnings management. Emotionally impactful events, such as terrorist attacks and mass shootings, can influence managers when they’re making financial decisions by increasing their perceived probability of risk and negative future events.

“My research supports the argument that managers exhibit a cognitive bias which affects their financial reporting choices,” Oz said in an email.

The study suggests that companies may need to reconsider their internal policies to account for such psychological effects, which could result in more ethical business practices and improved regulations in the future.