Shareholders' Wealth-Maximizing Operating Decisions and Risk Management Practices in a Mixed Contracts Economy

• Published in: Production and operations management 2010-07, Vol.19 (4), p.418-433
• Main Authors: Rao, Ramesh K. S., Gutierrez, Genaro J.
• Format: Article
• Language: English
• Subjects: Arbitrage; Bankruptcy; cash; Costs; Decision making; factor contracts; financial hedging; Hedging; Impact analysis; Investments; Investors; lean production; Management decisions; mixed contracts; non-tradability premium; operational hedging; Operations management; Private equity; Productivity; productivity of capital; Proprietorships; Risk management; shareholder wealth; Shareholders wealth; Stockholders; Studies; Utility functions; Working capital
• ISSN: 1059-1478; 1937-5956
• DOI: 10.1111/j.1937-5956.2010.01115.x

This paper establishes a critically important positive role for operations management practices and financial hedging. We show that operations management decisions and financial hedging are intertwined, and we advance a framework that can identify their combined effects on investors' wealth. We show that: (a) firms (publicly traded corporations) will optimally hold adequate riskless working capital (e.g., cash) to minimize the cost of obtaining non‐financial inputs, and the magnitude of this cash holding depends on operating details, and (b) operations management and financial hedging can lower firms' cash requirements, and boost productivity, defined as the wealth created in the firm per dollar of invested capital. Productivity‐enhancing practices—by “freeing up” some of the firm's cash—can maximize the investors' wealth. We show that these results obtain because firms' contracts with many of the providers of non‐financial inputs are not traded, and because investors can invest not just in public corporations but also in businesses “outside the markets” (e.g., proprietorships, partnerships, and private equity).