Information Cascade and 2011 Netflix Stock
One of the most common observances of information cascades can be seen right in the stock markets. Information cascades can either be good or bad, but unfortunately for Netflix in 2011, information cascade was terrifying. In September 2011, Netflix raised the subscriber price due to pressures from studios and their licenses and competition with other video streaming services. Because of the rise in price, many subscribers were angry and frustrated. So much so, that around 800,000 subscribers left Netflix. However, this was not the most painful part of Netflix’s 2011 catastrophe. The exodus of 800,000 subscribers caused many investors to fear that Netflix will stop growing soon and thus many investors sold their stocks of Netflix. This resulted in the initial 19% drop in Netflix stock. Soon after the 19% drop, because of the information cascade playing a big role in stock markets, Netflix stock dropped another 35%.
The first 19% drop was inevitable. Even though the company did not change the leadership or their profit numbers, losing a significant portion of the user base would most likely instill fear in many investors that the company would be under-performing next quarter. However, this initial drop was not due to the effects of information cascade. This was simply a reaction to a specific company related news. The second drop, on the other hand, was mainly caused by the effects of information cascade. Because all the participants (investors) in the market use public information only (insider trading is illegal), all the other Netflix investors did not have every information about Netflix and what other investors were thinking when they sold their stocks. With no new information to base their action other than the fact that a significant portion of investors have backed away and sold their shares, Netflix shareholders began to fear that perhaps something serious will happen to the company that they did not know but the other investors did. Therefore, due to the fear, many other investors sold their shares and resulted in the 35% drop in Netflix stock. Using the fundamentals of information cascades, since the investors did not have any other information other than the fact that many other investors sold their stocks, these investors only had to base their decisions on actions of others and public information that everyone knows.