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Do investors forecast fat firms? Evidence from the gold-mining industry

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  • Severin Borenstein
  • Joseph Farrell

Abstract

Conventional economic theory assumes that firms always minimize costs given the output they produce. News articles and interviews with executives, however, indicate that firms from time to time engage in cost-cutting exercises. One popular belief is that firms cut costs when they are in economic distress, and grow fat when they are relatively wealthy. We explore this hypothesis by studying the response of the stock market values of gold mining companies to changes in gold prices. The value of a cost-minimizing, profit-maximizing firm is convex in the price of a competitively supplied input or output, but we find that the stock values of many gold mining companies are concave in the price of gold. We show that this is consistent with fat accumulation when a firm grows wealthy. We then address a number of potential alternative explanations and discuss where fat in these companies might reside.

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Bibliographic Info

Article provided by RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 38 (2007)
Issue (Month): 3 (09)
Pages: 626-647

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Handle: RePEc:bla:randje:v:38:y:2007:i:3:p:626-647

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  1. Pindyck, Robert S, 1993. "The Present Value Model of Rational Commodity Pricing," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 103(418), pages 511-30, May.
  2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
  3. Peter Tufano, 1998. "The Determinants of Stock Price Exposure: Financial Engineering and the Gold Mining Industry," Journal of Finance, American Finance Association, American Finance Association, vol. 53(3), pages 1015-1052, 06.
  4. Olivier J. Blanchard & Florencio Lopez-de-Silane, 1993. "What do Firms do with Cash Windfalls?," NBER Working Papers 4258, National Bureau of Economic Research, Inc.
  5. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, American Finance Association, vol. 57(2), pages 815-839, 04.
  6. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
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Cited by:
  1. Jose E. Galdon Sanchez & James A. Schmitz, Jr., 1999. "Threats to industry survival and labor productivity: world iron-ore markets in the 1980's," Staff Report, Federal Reserve Bank of Minneapolis 263, Federal Reserve Bank of Minneapolis.
  2. Juha Kilponen & Torsten Santavirta, 2005. "Competition and Innovation - Microeconometric Evidence Using Finnish Data," Industrial Organization, EconWPA 0509009, EconWPA.
  3. David Levinson & Reinaldo Garcia & Kathy Carlson, 2001. "A Framework for Assessing Public Private Partnerships," Working Papers, University of Minnesota: Nexus Research Group 200712, University of Minnesota: Nexus Research Group.
  4. Jose E. Galdon-Sanchez & James A. Schmitz, Jr., 2003. "Competitive pressure and labor productivity: world iron ore markets in the 1980s," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr, pages 9-23.
  5. Behar Alberto & Hodge James, 2008. "The Employment Effects of Mergers in a Declining Industry: The Case of South African Gold Mining," The B.E. Journal of Economic Analysis & Policy, De Gruyter, De Gruyter, vol. 8(1), pages 1-20, August.
  6. Leemore Dafny, 2008. "Are Health Insurance Markets Competitive?," NBER Working Papers 14572, National Bureau of Economic Research, Inc.
  7. Benjamin Bridgman, 2011. "Competition, Work Rules and Productivity," 2011 Meeting Papers 289, Society for Economic Dynamics.
  8. Doh-Shin Jeon, 2003. "A Theory of Information Flows," Working Papers 77, Barcelona Graduate School of Economics.
  9. Joseph Farrell & Severin Borenstein, 2000. "Is Cost-Cutting Evidence of X-Inefficiency?," American Economic Review, American Economic Association, American Economic Association, vol. 90(2), pages 224-227, May.
  10. Doh Shin Jeon, . "Relying on the agent in charge of production for project evaluation," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 623, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2006.
  11. Leemore S. Dafny, 2010. "Are Health Insurance Markets Competitive?," American Economic Review, American Economic Association, American Economic Association, vol. 100(4), pages 1399-1431, September.
  12. Maliranta, Mika, 2002. "From R&D to Productivity Through Micro-Level Restructuring," Discussion Papers, The Research Institute of the Finnish Economy 795, The Research Institute of the Finnish Economy.

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