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

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Listed:
  • Severin Borenstein
  • Joseph Farrell

Abstract

JEL CODES: D21, G3, L2, L72 KEYWORDS: profit function, free cash flow, gold mining, x-efficiency, rent seeking, fat 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 how the stock market valuations of gold mining companies vary with 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.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Severin Borenstein & Joseph Farrell, 2007. "Do investors forecast fat firms? Evidence from the gold-mining industry," RAND Journal of Economics, RAND Corporation, vol. 38(3), pages 626-647, September.
    • Handle: RePEc:bla:randje:v:38:y:2007:i:3:p:626-647
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    File URL: http://hdl.handle.net/10.1111/j.0741-6261.2007.00104.x
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    References listed on IDEAS

    as
    1. E. A. Selvanathan, 1991. "A Note on the Accuracy of Business Economists' Gold Price Forecasts," Australian Journal of Management, Australian School of Business, vol. 16(1), pages 91-94, June.
    2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    3. John R. Graham & Daniel A. Rogers, 2002. "Do Firms Hedge in Response to Tax Incentives?," Journal of Finance, American Finance Association, vol. 57(2), pages 815-839, April.
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    5. Blanchard, Olivier Jean & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 1994. "What do firms do with cash windfalls?," Journal of Financial Economics, Elsevier, vol. 36(3), pages 337-360, December.
    6. Rosanne Altshuler & Alan J. Auerbach, 1990. "The Significance of Tax Law Asymmetries: An Empirical Investigation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 105(1), pages 61-86.
    7. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," The Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
    8. Tufano, Peter, 1996. "Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
    9. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
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    11. James A. Schmitz Jr., 2005. "What Determines Productivity? Lessons from the Dramatic Recovery of the U.S. and Canadian Iron Ore Industries Following Their Early 1980s Crisis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 582-625, June.
    12. Pindyck, Robert S, 1993. "The Present Value Model of Rational Commodity Pricing," Economic Journal, Royal Economic Society, vol. 103(418), pages 511-530, May.
    13. Marianne Bertrand & Sendhil Mullainathan, 2001. "Are CEOs Rewarded for Luck? The Ones Without Principals Are," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(3), pages 901-932.
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    More about this item

    Keywords

    profit function; free cash flow; gold mining; x-efficiency; rent seeking; fat 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 how the stock market valuations of gold mining companies vary with 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.
    (this abstract was borrowed from another version of this item.)    ;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • G3 - Financial Economics - - Corporate Finance and Governance
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • L72 - Industrial Organization - - Industry Studies: Primary Products and Construction - - - Mining, Extraction, and Refining: Other Nonrenewable Resources

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