How does operational risk in supply chain affect stock returns? role of capacity utilization in reducing income volatility

Abstract

Knowledge and insights on supply chain operational risk is accumulating and consolidating rapidly. This study aims to fill in a relatively less explored area of supply chain risk by assessing the impact of operational risk on income volatility and stock returns. We present two sets of empirical findings. First, we compare operational risk across upstream and downstream industries. Compared with companies in downstream industries, those in upstream industries have little opportunity of outsourcing and have to commit to the long-term production resources for themselves. Our empirical tests show that upstream firms operating income is more volatile and, as a result, their stock returns are lower compared to downstream firms. Second, in our attempt to better understand a channel through which operational risk affects stock returns, we find that high income volatility in upstream firms is attenuated when capacity utilization is high. In sum, our results suggest that operational risk in supply chain affects stock returns through limited production activities amplifying the impact of fixed costs on earnings stream.