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The Black Swan problem : The role of capital, liquidity and operating flexibility

Christie, Nick LU ; Jankensgård, Håkan LU and Marinelli, Nicoletta (2024) In International Review of Financial Analysis 91.
Abstract

How firms cope with tail risk is an under-researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30%–90%. The rate of Black Swans has increased markedly since the 1970's and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash... (More)

How firms cope with tail risk is an under-researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30%–90%. The rate of Black Swans has increased markedly since the 1970's and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash reserves and cash margins make firms less fragile, but neither equity capital nor operating flexibility robustly buffer against Black Swans. The results continue to hold when we restrict the analysis to transient and cyclical revenue shocks, as well as when we use only a strictly exogenous revenue shock based on the airline industry.

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organization
publishing date
type
Contribution to journal
publication status
published
subject
keywords
Black swan, Financial constraints, Financial slack, Revenue risk, Risk capital
in
International Review of Financial Analysis
volume
91
article number
103024
publisher
North-Holland
external identifiers
  • scopus:85176094392
ISSN
1057-5219
DOI
10.1016/j.irfa.2023.103024
language
English
LU publication?
yes
id
ba5a43cb-fdd1-4ffa-8a99-081176674e8b
date added to LUP
2023-11-24 12:03:59
date last changed
2023-11-24 12:05:29
@article{ba5a43cb-fdd1-4ffa-8a99-081176674e8b,
  abstract     = {{<p>How firms cope with tail risk is an under-researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30%–90%. The rate of Black Swans has increased markedly since the 1970's and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash reserves and cash margins make firms less fragile, but neither equity capital nor operating flexibility robustly buffer against Black Swans. The results continue to hold when we restrict the analysis to transient and cyclical revenue shocks, as well as when we use only a strictly exogenous revenue shock based on the airline industry.</p>}},
  author       = {{Christie, Nick and Jankensgård, Håkan and Marinelli, Nicoletta}},
  issn         = {{1057-5219}},
  keywords     = {{Black swan; Financial constraints; Financial slack; Revenue risk; Risk capital}},
  language     = {{eng}},
  publisher    = {{North-Holland}},
  series       = {{International Review of Financial Analysis}},
  title        = {{The Black Swan problem : The role of capital, liquidity and operating flexibility}},
  url          = {{http://dx.doi.org/10.1016/j.irfa.2023.103024}},
  doi          = {{10.1016/j.irfa.2023.103024}},
  volume       = {{91}},
  year         = {{2024}},
}