Hedging against Disasters
Journal of Operations Management, 2008
How do companies hedge against the effects of disasters such as terrorist attacks? While many companies use financial instruments to hedge currency fluctuations, fuel cost increases and changes in interest rates, Professor Michael Maher and his co-author Professor Dan Weiss of Tel Aviv University studied the use of operations policy to hedge against unfavorable situations. A classic example is the ice cream parlor owner in a summer resort town who adds hot drinks to her menu to hedge against an unusually cold summer.
Maher and Weiss’ study, “Operational Hedging Against Adverse Circumstances” will be published in the Journal of Operations Management. Their research offers a new method to evaluate the extent that operations policy serves as a hedge against adverse circumstances. Their method explores how supply chain characteristics affected the responses of airlines to the severe drop in demand after the September 11 terrorist attacks.
The authors found that during the post-9/11 economy, airlines that were most hedged outperformed those that were not. Based on operating results in the 1990s, the authors found that Southwest Airlines and SkyWest were most hedged while America West and U.S. Airways were least hedged. Southwest and SkyWest did not earn the highest total profits in the 1990s, but they experienced the fewest quarters with losses.
Maher and Weiss’ findings indicate that operational hedging vehicles (fleet standardization, high fleet utilization, an aircraft ownership policy rather than leasing, and international operations) are more powerful in protecting firms than using financial instruments. The study contributes in guiding managers as to how operations policy can be a critical factor in mitigating exposures to low-end performance levels.
Maher’s and Weiss’ study won the Best Paper Award at the Second European Risk Conference at Universita Bocconi in September. The paper has also been presented at the American Accounting Association annual meetings and the 27th European Accounting Association Annual Congress in Prague.