The Effect of Experiencing a Catastrophic Event on Inventory Decisions

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Low probability high consequence (lp-hc) risk events, such as specific natural disasters, are characterized by limited availability of historical and scientific data. In situations in which data is difficult to obtain, risk assessment becomes a resource intense task, in which managers must partly rely on their own perceptions. Perception based risk management responses are yet often biased by prior exposure to lp-hc events, with entailing financial performance consequences. This study investigates inventory levels, as a typical risk response, of manufacturers in the post recovery-phase of the 2011 Great East Japan Earthquake (GEJE). It considers raw material (RAW), work-in-progress (WIP) and finished goods (FG). We observe a significant buildup of RAW and lagged decreases of WIP and FG after the GEJE. Investigating the relationship between observed responses and firm risk-preferences, some light is shed on the question of whether observed reactions were driven by experiential learning, or are, to a significant extent, a reaction to changed risk perceptions. Results indicate that risk-averse firms reacted significantly stronger to the event. Supporting the assumption of partly perception-based adjustments of RAW inventories, and learning-based adjustments of WIP and FG. Across all firms, the observed reactions reduced the firms’ return on assets by 0.428 percentage points. The GEJE provides an interesting case, as the risk of a similar event happening again did hardly change after 2011, suggesting observed managerial responses to be independent of a changed risk environment. As quantitative accounts of managerial responses to lp-hc events in general and the GEJE in particular are largely absent from the literature, this study advances our understanding of how firms frame such risks as to ascertain their decision-making process. The details of the observed response patterns are also of interest to insurers, investors and standard-setting organizations.