RISK PROPENSITY AND FIRM PERFORMANCE - A STUDY OF THE PETROLEUM-EXPLORATION INDUSTRY

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 p ropensity in the form of an ''implied'' utility function; (2) investig ate changes in corporate risk propensity with respect to changes in fi rm size; and (3) examine the relationships between firms' risk propens ities 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 propen sity. The motivation for this work is managerial concerns regarding ap propriate risk-laking behavior and the effect of risky choice on firm performance. This methodology has importance business strategy implica tions in that we are able to make strong inferences about causal relat ionships between ex ante risk-taking and performance. Our findings are compelling in that corporate risk propensity seems to matter, and tha t decisions about corporate risk policy have a significant impact on t he petroleum firm's economic performance.