Two essays on value generation and market valuation of firms
by Shengquan Hao
ix, 121 leaves : ill. ; 30 cm
Essay 1: Relative Firm Profitability and Stock Price Sensitivity to Aggregate Information...[ Read more ]
Essay 1: Relative Firm Profitability and Stock Price Sensitivity to Aggregate Information
This study provides theory and evidence to show how a firm’s profitability, relative to that of its industry peers, affects its stock price sensitivity to aggregate (industry and market-wide) information. We predict and empirically show that in a given industry, the returns of less profitable firms are more highly correlated with industry returns, which suggests higher industry betas, than those of more profitable firms. We further show that this is so after controlling for price movements attributed to common risk factors and firm-specific accounting information. We then extend the analysis to market-wide news and find a similar inverse relation between relative profitability and the market beta. Finally, we show that a mimicking portfolio for relative profitability has an incremental power to explain cross-sectional returns beyond the market portfolio and size, book-to-market, and momentum factors.
Essay 2: How successfully do firms create value for investors?
This study provides empirical evidence on how successful companies create value for equity investors (as measured by residual income) and how effective the capital markets are in anticipating the value generation of firms. Based on a sample of listed companies in the U.S. economy, we find that only about 48% of the firms in all industries create a positive value for equity investors in a given year, and that only 37% of firms actually create a positive value in the long run, as measured by the present value of future residual income. We also find that the amount of value created by profitable firms is nearly offset by the amount of value destroyed by unprofitable firms in a typical industry during the initial period when the industry is experiencing a net increase in the total number of firms, although this situation later improves in the shakeout period when the industry experiences a net decline in the number of firms. A firm’s value creation is found to be negatively related to the degree of competition in its industry and positively related to its past profitability and size. Capital markets are identified as being more accurate in valuing profitable firms than unprofitable firms. Furthermore, market valuation errors are gradually corrected for profitable firms, but not for unprofitable firms. On average, the market values of firms are higher than the intrinsic values, with overvaluation being the most serious for the most inefficient (value-destroying) firms.
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