Risk taking over gains and losses: A study of oil executives

This paper examines the risk propensities of experienced executives in the oil and gas industry faced with a hypothetical risky business decision that involves significant gains and losses. The executives were asked to provide the minimum price their firm should accept before selling their share of a joint exploration venture whose future prospects were systematically varied to include gains only, losses only, and mixed gains and losses. In addition, they were asked to provide a single probability equivalence for a mixed gain/loss situation in lieu of breaking even for sure. The executives were more risk taking than risk averse over pure losses, consistent with the prediction of prospect theory. Over pure gains, however, there was as much risk taking as risk aversion, with more risk taking occurring when the chance of breaking even was higher. The relationship between risk propensity over pure gains and over pure losses was insignificant, indicating very different attitudes in these two domains. Although the reflection effect did occur in some cases, it was not pervasive. There was a tendency for certainty equivalences to show greater risk taking than probability equivalences in mixed gain/loss situations. which was consistent with a reframing effect. Risk propensity over mixed gains and losses was closer to that expressed in the losses only domain than to risk propensity over pure gains. More than half of the executives gave responses that were fully consistent with expected utility, and an additional quarter of executives were consistent within a 10% margin of error in their responses. However, one out of five executives did not satisfy the stochastic dominance relationships among the certainty equivalences. Systematic inconsistencies occurred most frequently in the mixed situations where the certainty equivalences for some subjects were biased toward the outcome that had the predominant chance of occurring.