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Too Much of a Good Thing?

Author

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  • Dana R. Clyman

    (Darden Graduate School of Business, University of Virginia, Charlottesville, Virginia 22906)

  • Michael R. Walls

    (Division of Economics and Business, Colorado School of Mines, Golden, Colorado 80401)

  • James S. Dyer

    (Department of Management Science and Information Systems, University of Texas at Austin, Austin, Texas 78712)

Abstract

This paper explores a seemingly paradoxical phenomenon associated with the use of expected-utility theory in capital-budgeting and risk-sharing decisions under uncertainity. As an investment prospect becomes better and better, decision makers using classic decision-analysis techniques may, in fact, prefer less and less of it. We explore this phenomenon in the very real context of petroleum company drilling-investment decisions and demonstrate that the phenomenon is pervasive. When we examined the prospect inventory of a major oil company, we found that an increase in the upside payoff would lead to a lower optimal working interest for the grand majority of its prospects. We also explore the underlying factors leading to this phenomenon to develop both intuition and understanding. These factors have to do with degree of risk aversion (the more risk averse you are, the less likely you are to increase your holdings of an improving prospect) and managerial perspectives on risk. Once understood, the results no longer seem surprising.

Suggested Citation

  • Dana R. Clyman & Michael R. Walls & James S. Dyer, 1999. "Too Much of a Good Thing?," Operations Research, INFORMS, vol. 47(6), pages 957-965, December.
    • Handle: RePEc:inm:oropre:v:47:y:1999:i:6:p:957-965
    DOI: 10.1287/opre.47.6.957
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    References listed on IDEAS

    as
    1. Michael R. Walls & James S. Dyer, 1996. "Risk Propensity and Firm Performance: A Study of the Petroleum Exploration Industry," Management Science, INFORMS, vol. 42(7), pages 1004-1021, July.
    2. Michael R. Walls & G. Thomas Morahan & James S. Dyer, 1995. "Decision Analysis of Exploration Opportunities in the Onshore US at Phillips Petroleum Company," Interfaces, INFORMS, vol. 25(6), pages 39-56, December.
    3. David E. Bell, 1988. "One-Switch Utility Functions and a Measure of Risk," Management Science, INFORMS, vol. 34(12), pages 1416-1424, December.
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    Citations

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    Cited by:

    1. Craig W. Kirkwood, 2004. "Approximating Risk Aversion in Decision Analysis Applications," Decision Analysis, INFORMS, vol. 1(1), pages 51-67, March.
    2. Wang, Charles X. & Webster, Scott & Suresh, Nallan C., 2009. "Would a risk-averse newsvendor order less at a higher selling price?," European Journal of Operational Research, Elsevier, vol. 196(2), pages 544-553, July.
    3. Jano-Ito, Marco A. & Crawford-Brown, Douglas, 2017. "Investment decisions considering economic, environmental and social factors: An actors' perspective for the electricity sector of Mexico," Energy, Elsevier, vol. 121(C), pages 92-106.

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