Cockroach Theory in Finance

Cockroach Theory in Finance refers to the observation that companies that report unexpected bad news to their investors may report even more negative news in the future. It is generally used to warn investors about the likelihood of bigger problems emanating from companies that are not transparent in their reporting to investors.

The theory is named after the common observation that the presence of a single cockroach in the kitchen likely suggests that there may be more hidden in the same area. Many investors might refrain from investing in companies that have reported bad news as they expect worse to follow.