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Terrorism Activities and Management Forecasts

By Augustine Duru, Kogod School of Business American University; Yangyang Fan, Hong Kong Polytechnic University; Christo Pirinsky, University of Central Florida; Mikhail Pevzner, Merrick School of Business, University of Baltimore.


We study the effect of terrorist attacks on the disclosure policies of local firms. We find that the managers of firms located closer to the epicenters of the attacks are more likely to issue optimistic earnings forecasts relative to the managers of a control group of unaffected firms. The exposure-effect on managerial optimism intensifies for firms with stronger geographic focus, more uncertain fundamentals, larger R&D expenditures, and greater need for external equity financing. More capable managers tend to be more optimistic following a terrorist event. Our results are consistent with the idea that earnings forecasts are used by managers to counterbalance negative investor sentiment in capital markets.

1. Introduction

While there is a general understanding in the literature that investor sentiment could significantly affect firm investment, financing, and accounting practices, the implications of sentiment for disclosure policy remain unclear.(1) There are two opposing views on managerial response to shifts in investor sentiment – to “ride” the sentiment or to counterbalance its effects. Yet, the existing empirical evidence seems to be consistent with both views – some researchers find that managers tend to bias their voluntary disclosure policy in the direction of the sentiment (e.g., Hribar and McInnis, 2012; Brown et al., 2012), while others find that managers adjust their voluntary disclosure policy against the direction of the sentiment (Seybert and Yang, 2012; Bergman and Roychowdhury, 2008). One possible reason for the mixed evidence on the implications of sentiment for firms’ voluntary disclosure choices is that identifying a causal relationship between investor sentiment and a firm’s corporate policy is challenging.

In this paper, we use terrorist attacks as an exogenous shock to local investor sentiment. Specifically, we identify 93 cases of terrorist acts across the U.S. from 1997 to 2016 from the Global Terrorism Database and investigate whether the earnings forecasts of managers of firms exposed to the terrorist shock (treatment group) are different from the earnings forecasts of managers not exposed to the terrorist shock (control group). Existing research in psychology has established that exposure to terrorist acts exhibits an emotional impact on individuals (e.g. Galea et al., 2002; Hughes et al., 2011). Consistent with this research, recent empirical studies in finance (e.g., Wang and Young, 2019, Nikkinem and Vahamaa, 2010; Burch et al., 2003) show that terrorist acts could depress investor sentiment and significantly increase their risk aversion. This empirical evidence and the fact that terrorist acts are unpredictable and largely exogenous with respect to the firm and its investors allow us to design a stronger identification test for the implications of investor sentiment for managerial disclosure policy.

Management earnings forecasts are particularly well-suited for detecting the potential effect of terrorist activities (and thus investor sentiment) on corporate disclosure for several reasons. First, because management forecasts are voluntary, managers have the flexibility to strategically adjust the characteristics of the forecasts in response to the prevailing sentiment. Second, management earnings forecasts account for a large proportion of the information used by investors in modern markets (Beyer et al., 2010). Not surprisingly, extensive research has shown that management earnings forecasts can influence both stock prices and analysts’ opinions (e.g., Ajinkya and Gift, 1984; Baginski, Conrad, and Hassell, 1993; Matsumoto, 2002; Anilowski et al., 2007). Third, recent empirical evidence indicates that management forecasts represent timelier information events than earnings announcements (e.g., Kato et al., 2009). Finally, management earnings forecasts are forward-looking and highlight managers’ judgement call in corporate decision making, thus providing an opportunity for a test of the effect of a mood-induced bias on managers’ judgement.

We consider two possible responses of management to shifts in investor sentiment – reinforcing and neutralizing. (2) According to the reinforcing view, the adverse shock to local investor sentiment causes managers to issue pessimistic earnings forecasts. Managers might not be immune to the sentiment shock affecting other market participants and, in response, could issue pessimistic forecasts following exposure to terrorist events (e.g., Baker et al. 2012; Ben-David, Graham, and Harvey, 2013; Bergman and Roychowdhury, 2008; Brown et al., 2012; Hribar and Yang, 2016). This argument draws from an established body of academic research demonstrating that shocks to managers’ emotions can generate mood-induced biases (e.g., Schwarz and Clore, 1983; Kamstra et al., 2003; Guiso et al. 2018).

The neutralizing view suggests that managers could counterbalance the negative effect of terrorist events with optimistic earnings forecasts. There are two main reasons why managers might choose to do so. First, management is generally better informed about firms’ performance than outside investors and thus may be less affected by sentiment.3 Second, managers are generally over-confident about their abilities (e.g., Griffin and Tversky, 1992; Malmendier and Tate, 2008) and thus more likely to express positive outlook about their firms even when market participants have doubts about the prospects of these firms (e.g., Moore and Healy, 2008). In sum, systematic factors such as overconfidence could prompt managers to provide more optimistic earnings forecasts during low-sentiment periods to correct the pessimistic investor outlook and boost stock prices.

In line with the neutralizing view, we find that managers of firms in close proximity to terrorist events are more likely to issue more optimistic earnings forecasts following the event. The exposure effect is both statistically and economically significant. The difference-in-differences model, combined with extensive controls for time-varying covariates and firm, year, industry, and state-fixed effects, suggests a causal interpretation of our results. Our baseline results are also robust to evaluating management earnings forecasts relative to the forecasts of financial analysts – effectively a triple difference-in-differences estimation. A parallel trends analysis further suggests that the difference in bias between the treatment and control groups is due to the attacks and not a consequence of pre-existing shocks not related to the attacks.

We also find that the positive impact of terrorist attacks on managerial optimism is more pronounced for firms with stronger local bias measured by firm size and the proportion of local equity investors (located within 100 miles from the firm headquarters). This results is consistent with the idea that firms with stronger local bias are more embedded in the local community and, as a result, more vulnerable to the terrorist event (e.g., Wang and Young, 2019).

To further validate our baseline results, we perform a series of additional tests. We find that managerial optimism increases with the severity of the attack. We also show that the increase in managerial optimism following terrorist attacks is concentrated among firms with more uncertain fundamentals, such as more volatile firms and firms with larger standard deviation of their analyst forecasts. Since firms exposed to larger shocks and firms with more uncertain fundamentals are more likely to be mispriced, these results lend further support for the neutralizing view on managerial optimism.

The neutralizing view on managerial optimism following terrorist attacks implicitly assumes that managers are in a better position to process available information than outside investors. If this interpretation is correct, we would also expect that managers with greater ability would tend to exhibit stronger degree of optimism following a terrorist event. Consistent with this argument, Baik et al. (2011) show that managerial ability enhances the accuracy and credibility of management forecasts. Measuring CEO ability with industry-adjusted ROA of the firm, we confirm that management forecast optimism following a terrorist event increases at a higher rate for firms with CEOs of higher-ability.

Suggested Citation:

Duru, Augustine and Fan, Yangyang and Pirinsky, Christo Angelov and Pevzner, Mikhail, Terrorism Activities and Management Forecasts (January 3, 2020). Available at SSRN: or


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