The September 11 Terrorist Attack, the Enron Scandal, and the Stock Market
In 2001, two big shocks hit the stock market: the September 11 terrorist attack and the Enron scandal. Our analysis of stock price evaluation, again using the Gordon growth model, can help us understand how these events affected stock prices. The September 11 terrorist attack raised the possibility that terrorism against the United States would paralyze the country. These fears led to a downward revision of the growth prospects for U.S. companies, thus lowering the dividend growth rate g in the Gordon model. The resulting rise in the denominator in Equation 5 should lead to a decline in P0 and hence a decline in stock prices. Increased uncertainty for the U.S. economy would also raise the required return on investment in equity. A higher ke also leads to a rise in the denominator in Equation 5, a decline in P0, and a general fall in stock prices. As the Gordon model predicts, the stock market fell by over 10% immediately after September 11. Subsequently, the U.S. successes against the Taliban in Afghanistan and the absence of further terrorist attacks reduced market fears and uncertainty, causing g to recover and ke to fall. The denominator in Equation 5 then fell, leading to a recovery in P0 and the stock market in October and November. However, by the beginning of 2002, the Enron scandal and disclosures that many companies had overstated their earnings caused many investors to doubt the formerly rosy forecast of earnings and dividend growth for corporations. The resulting revision of g downward, and the rise in ke because of increased uncertainty about the quality of accounting information, should have led to a rise in the denominator in the Gordon Equation 5, thereby lowering P0 for many companies and hence the overall stock market. As predicted by our analysis, this is exactly what happened. The stock market recovery was aborted and it entered a downward slide.