Working Paper: NBER ID: w7075
Authors: 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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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Gold Prices (G13) | Firm Valuations (G32) |
| Wealth Accumulation (E21) | Firm Inefficiencies (Fat) (D21) |
| Firm Valuations (G32) | Convexity of Value Function (C61) |
| Gold Prices (G13) | Convexity of Value Function (C61) |
| Confounding Factors (C39) | Observed Relationship (Gold Prices and Firm Valuations) (G39) |