RISKY CHOICE, RISK SHARING AND DECISION-ANALYSIS - IMPLICATIONS FOR MANAGERS IN THE RESOURCE SECTOR

This paper provides a brief overview of decision and preference analys is concepts and demonstrates an application of these techniques to the project-valuation problem faced by resource managers. Our major focus is on the use of the exponential utility function, the utility functi on most frequently used by resource companies. We discuss the importan t and practical risk-sharing problem faced by managers in the resource sector, that is, how to choose the optimal share of a risky project. We demonstrate that with decision and preference analysis tools it can be quite straight forward for managers to identify their optimal shar e in risky projects. We then explore these techniques further and demo nstrate that they can lead to some seemingly counter-intuitive results . In particular, we explore how the firm's optimal share changes with exogeneous changes in project parameters. What we find is that while m any of the changes in share are intuitive, some are not. In fact, when the firm's estimate of the potential upside payoff upon finding reser ves increases, it is sometimes better to decrease the firm's share tha n it is to increase it. This is important, because by recognizing this counter-intuitive result, we can work to improve our intuition by und erstanding it. We summarize our findings and offers some guidelines re source managers should consider when considering a choice of utility f unction. (C) 1998 Elsevier Science Ltd, All rights reserved.