Do Investors Forecast Fat Firms? Evidence from the Gold Mining Industry
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.