Earthquakes: Nature’s Curse or a Blessing in Disguise?

Abstract

Earthquakes are a major source of destruction. They destroy roads, ports, power plants, fixed assets, disrupt supply chains. All this destruction/disruption should negatively affect the firm. Particularly it should destroy value (market capitalization) and cash flows. An alternative view is based on Schumpeter’s (1942) creative destruction. If earthquakes provide firms with the opportunity to change/improve technology, (lower the cost of adoption of new technology) they should have a positive effect on firm value and cash flows. We test this hypothesis using a sample of 299 earthquakes that occurred between 1990 and 2004 and a large panel sample of firms from over 50 countries. We find mixed evidence regarding creative destruction: Earthquake damage is generally positively correlated with market capitalization providing support for the creative destruction hypothesis. Earthquakes create value. However, a closer look shows that this result is valid only for firms in less developed countries, particularly firms from non G8 countries. We find that in fact earthquakes destroy value for firms in the G8. We interpret this as a sign that innovation can be easier in poorer countries where the economies of scale of adopting new technologies are bigger. Overall, earthquake damage is negatively correlated with operational cash flows, supporting a negative view of earthquakes. We find also that this effect is persistent in time. Even after 3 years, companies feel a reduction in their cash flows. However, this reduction in cash flows is not true for all countries. We show that firms from Latin America and Asia; the regions most affected by earthquakes experience an increase in operational cash flow. Finally, we show that multinationality helps reduce the reduction in cash flows associated with earthquake damage.