Cost Management in the Era of Natural Disasters

Using a sample of U.S. companies from 1993 to 2019, we examine how managers respond to natural disasters in their cost management decisions. We find no significant cost management response among firms located in directly affected regions, potentially due to offsetting forces. However, we find robust evidence that cost behavior changes for firms located in geographically proximate but unaffected regions. Specifically, managers of these firms are more likely to reduce SG&A costs in response to sales declines following a nearby natural disaster. Additional analyses suggest that this response can be ascribed to irrational managerial pessimism, which is not economically justified, as neighboring counties are not more likely to experience future natural disasters and these firms do not face contemporaneous sales declines after nearby events. These findings are consistent with salience theory, which suggests that managers become more pessimistic after being exposed to salient negative events, even when their firms are not directly affected. Overall, our results highlight the important role of behavioral biases in corporate cost management and are particularly timely given the increasing frequency and severity of natural disasters associated with climate change.