Cockroach Theory - Explained
What is the Cockroach Theory?
Written by Jason Gordon
Updated at April 17th, 2022
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Table of Contents
What is the Cockroach Theory?How Does the Cockroach Theory Work?Cockroach Theory at WorkThe Effects of Cockroach TheoryWhat is the Cockroach Theory?
The cockroach theory is a market theory that states that a piece of bad news in the market indicates that there is much more bad news. As suggested by this theory, if one company in a sector reveals a piece of bad news to the public, other companies in that same sector are likely to encounter similar problems or events. The ideology behind the cockroach theory is the belief about a cockroach that the appearance of one in an area signals the presence of many others. The cockroach theory posits that the announcement of one negative news means many more negative events will occur to a company or an industry.
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How Does the Cockroach Theory Work?
The cockroach theory is a non-scientific market theory anchored on the belief when one problem or bad news is announced by a company, other companies in the sectors are also likely to break the bad news to the public. According to this theory, the success and performances of a company of industry are determined both internal and external factors. Hence in a sector, of one company reveals negative news or bad occurrences to the public, other companies in the same sector will experience similar events.
Cockroach Theory at Work
A popular example of the cockroach theory at work is the Enron's accounting problem or scandal that was revealed to the public. In 2001, it was disclosed that Enron deliberately falsified their accounts, by the time the scandal escalated in 2002, Enron was already bankrupt and the company that did her audits, Arthur Anderson had to relinquish its CPA license. Soon after Enron's scandal, it was discovered that other companies like WorldCom, Tyco and Adelphia had similar accounting problems. With the Enron scandal, fraudulent accounting practices in other companies in the industry were revealed which thereafter alerted the industry regulators.
The Effects of Cockroach Theory
The cockroach theory does not only have effects on a particular sector or industry, the entire market of affected. This is given that bad news in a sector of the market can have a ripple effect and spread to other sectors of the market. Also, negative news in the market alert investors and they begin to reconsider their investment in a particular market.