Skip to main content
SpringerLink
Log in

A stochastic investiment model for a survival conscious firm

  • Published:
Annals of Operations Research Aims and scope Submit manuscript

The economist as such does not advocate criteria of optimality. He may invent them. ... the ultimate choice is made by the procedures of decision making inherent in the institutions, laws and customs of society. Tjalling C. Koopmans, Nobel Memorial Lecture, 11th December 1975.

Abstract

A stochastic investiment is analyzed to show the consequences of an unwillingness by the entrepreneur to accept any positive risk of the firm's failure. The entrepreneur does not invest in additional capacity, even in the face of continuing positive expected profits, if that investment would infringe on the firm's ability to survive. Survival of the firm conditions all investment decisions, which are functions (via the physical and financial capital accounts) of the random outcomes observed at the time of decision. This conditioning shows how worse than expected outcomes will affect the firm's net asset position and its ability to survive. Managerially, the entrepreneur has principles by which to explicitly consider unpleasant surprises in planning for the continued growth of the firm. In contrast, knowledge of the random outcomes is shown to be of no consequence in an alternative model where maximization of expected profits is the sole criterion of the entrepreneur. In that model, the optimal investiment decisions can be made at the beginning of the firm's life, because those decisions are not functions of the future yields. Reduction of the survival model to a linear programming (LP) problem highlights the additional complexity of the survival problem. This reduction means that the maximum value of the objective function for the primal (expected profits) equals the minimum value of the objective function for the dual (resource costs), which economists interpret as zero profits. The zero profit consequence is in accordance with Knight's long-standing economic conjecture: If all risks are measureable, total risk aversion will result in no profits. Also, LP methods provide a way in application to analyze a wide range of risk possibilities from acceptance of no risk of failure to acceptance of some risk of failure.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  1. K.J. Arrow,Essays in the Theory of Risk-Bearing (North-Holland, Amsterdam, 1970).

    Google Scholar 

  2. K.J. Arrow, M.J. Beckman and S. Karlin, The optimal expansion of the capacity of the firm, in:Studies in the Mathematical Theory of Inventory and Production, eds. K.J. Arrow, S. Karlin and H. Scarf (Stanford University Press, Stanford, California, 1958) p. 92.

    Google Scholar 

  3. R. Bellman,Dynamic Programming (Princeton University Press, Princeton, New Jersey, 1957).

    Google Scholar 

  4. K.E. Boulding,Evolutionary Economics. (Sage Publications, Beverly Hills, 1983).

    Google Scholar 

  5. A. Charnes and W.W. Cooper, Chance-constrained programming. Management Science 6 (1959)73.

    Google Scholar 

  6. G.B. Dantzig,Linear Programming and Extensions. (Princeton University Press, Princeton, New Jersey, 1963).

    Google Scholar 

  7. G.B. Dantzig and A. Orden, Duality theorem, RAND Report RM-1265 The RAND Corporation, Santa Monica, CA., Oct. 1953).

    Google Scholar 

  8. R. Dorfman, P.A. Samuelson and R.M. Solow,Linear Programming and Economic Analayis (McGraw-Hill, New York, 1958).

    Google Scholar 

  9. R.J. Duffin, E.L. Peterson and C. Zener,Geometric Programming (Wiley, New York, 1967).

    Google Scholar 

  10. J.R. Hicks, Liquidity, The Economic Journal 72(1962)787.

    Google Scholar 

  11. J.R. Hicks, The theory of uncertainty and profit, Economica 11(1931)170.

    Google Scholar 

  12. F.H. Knight,Risk, Uncertainty and Profit (Houghton Mifflin, New York, 1921). Reprinted by London School of Economics and Political Science, London, 1946), 391 pp.

    Google Scholar 

  13. T.C. Koopmans, Objectives, constraints and outcomes in optimal growth models, Econometrica 35, No. 1(1967)1.

    Google Scholar 

  14. R.G. Thompson and M.D. George, Optimal operations and investments of the firm, Management Science 15, No.1(1968)49.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. College of Business Administration, University of Houston, 77004, Houston, Texas, USA

    Russell G. Thompson

  2. University of Missouri, 321 University Hall, 65211, Columbia, Missouri, USA

    Melvin D. George

Authors
  1. Russell G. Thompson
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Melvin D. George
    View author publications

    You can also search for this author in PubMed Google Scholar

Rights and permissions

Reprints and permissions

About this article

Cite this article

Thompson, R.G., George, M.D. A stochastic investiment model for a survival conscious firm. Ann Oper Res 2, 157–182 (1984). https://doi.org/10.1007/BF01874737

Download citation

  • Issue Date:

  • DOI: https://doi.org/10.1007/BF01874737

Keywords

Search

Navigation