The Black Swan problem: the role of capital, liquidity and operating flexibility

How firms cope with tail risk is an under-researched problem in the literature on corporate risk management. This paper presents stylized facts on the nature of revenue shocks based on 65 years worth of Compustat data. We define a Black Swan as an unexpected year-on-year drop in revenue between 30%–90%. The rate of Black Swans has increased markedly since the 1970’s and there are more pronounced cyclical peaks in the three most recent decades. We also examine the role of three general determinants of firms’ ability to absorb Black Swans: equity capital, liquidity, and operating flexibility. The conclusion to emerge from this analysis is that the deciding factor in mediating the effects of revenue shocks on employment is liquidity. Cash reserves and cash margins make firms less fragile, but neither equity capital nor operating flexibility robustly buffer against Black Swans. The results continue to hold when we restrict the analysis to transient and cyclical revenue shocks, as well as when we use only a strictly exogenous revenue shock based on the airline industry.