Financial and Operational Risk Management in the Gold Mining Industry

Abstract

Financial and operational risk management are central concepts at the intersection of finance, operations, and commodity risk management. Yet, empirical evidence on their effects on inventory is lacking. We use a fine-grained data set comprising the financial and operational risk management decisions of gold miners from 2003 to 2011 to empirically assess the effects of risk management on inventory. Faced with volatile gold prices, miners may manage (output) risk financially by committing to sell future gold production and lock in prices. They may also manage (input) costs operationally by varying the quality of ore they extract and process, thereby altering the costs they incur and influencing inventory holdings. In addition to affecting profitability, we show that these two risk management strategies have implications for inventory holdings. We find that a one-standard deviation increase in financial risk management (FRM) is associated with an 14.3% decrease in inventory, as FRM decreases the option value of delaying processing inventory. On the other hand, a one-standard deviation increase in operational risk management (ORM) is associated with a 3.5% increase in inventory. We also find evidence that, in this context, FRM and ORM could be viewed as complements.