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Risk Propensity and Firm Performance: A Study of the Petroleum Exploration Industry

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Author Info

  • Michael R. Walls

    (Division of Economics and Business, Colorado School of Mines, Golden, Colorado 80401)

  • James S. Dyer

    (Department of Management Science and Information Systems, University of Texas at Austin, Austin, Texas 78712)

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    Abstract

    This paper explores the differences in observed risk propensity among petroleum firms and their impact on firm performance. In this work, we (1) develop a decision theoretic model which measures a firm's risk propensity in the form of an "implied" utility function; (2) investigate changes in corporate risk propensity with respect to changes in firm size; and (3) examine the relationships between firms' risk propensities and alternative dimensions of economic performance, including ex post risk and return measures. We also develop a new risk propensity measure, the Risk Tolerance Ratio (RTR), which controls for firm size and allows firms to be differentiated in terms of relative risk propensity. The motivation for this work is managerial concerns regarding appropriate risk-taking behavior and the effect of risky choice on firm performance. This methodology has importance business strategy implications in that we are able to make strong inferences about causal relationships between ex ante risk-taking and performance. Our findings are compelling in that corporate risk propensity seems to matter, and that decisions about corporate risk policy have a significant impact on the petroleum firm's economic performance.

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    File URL: http://dx.doi.org/10.1287/mnsc.42.7.1004
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    Bibliographic Info

    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 42 (1996)
    Issue (Month): 7 (July)
    Pages: 1004-1021

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    Handle: RePEc:inm:ormnsc:v:42:y:1996:i:7:p:1004-1021

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    Related research

    Keywords: risk management; decision analysis; exponential utility; business strategy; firm performance; certainty equivalents; risk tolerance;

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    Cited by:
    1. Marco Cucculelli & Barbara Ermini, 2012. "Individual risk attitude, product innovation and firm performance. Evidence from survey data," Economics Bulletin, AccessEcon, vol. 32(4), pages 3197-3212.
    2. Mahdi Mattar & Charles Cheah, 2006. "Valuing large engineering projects under uncertainty: private risk effects and real options," Construction Management & Economics, Taylor and Francis Journals, vol. 24(8), pages 847-860.
    3. Les Coleman, 2005. "Why explore for oil when it is cheaper to buy?," Applied Economics Letters, Taylor and Francis Journals, vol. 12(8), pages 493-497.
    4. Manuel Cano Rodríguez & Manuel Núñez Nickel, 2002. "Problems With Extending Conclusions Between Bowman’S Paradox And Beta’S Deathk," Business Economics Working Papers wb024919, Universidad Carlos III, Departamento de Economía de la Empresa.
    5. Henkel, Joachim, 2007. "The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects," CEPR Discussion Papers 6538, C.E.P.R. Discussion Papers.
    6. Mohn, Klaus & Osmundsen, Petter, 2008. "Asymmetry and uncertainty in capital formation: An application to oil investment," UiS Working Papers in Economics and Finance 2009/13, University of Stavanger.

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