Abstract
In this paper, we investigate the role of firm efficiency in asset pricing using a sample of US publicly listed companies for the period 1988–2007. We employ non-parametric data envelopment analysis (DEA) on various input/output combinations, focusing on sales and market value as output measures in the construction of the frontier technologies. Using these performance measures, we examine whether efficient firms perform differently from inefficient firms following standard financial analysis procedures. First, we employ performance attribution regressions, by forming portfolios based on efficiency scores and tracking the performance of the various portfolios over time. Second, we perform cross-sectional/panel regressions to determine whether firm efficiency indeed has explanatory power for the cross-section of stock returns. Our results suggest that firm efficiency plays an important role in asset pricing and that efficient firms significantly outperform inefficient firms even after controlling for known risk factors.
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Notes
Distress risk is one way to link firm efficiency to the return on equity; efficiency affects the riskiness of the firm’s cash flows that in turn affect equity returns (see Nguyen and Swanson 2009).
When we estimate the model empirically we use the average output and the average input to define the directional vectors g y and g x .
See http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html for more details on the construction of these factors.
We observe a slight inverted U-shape pattern in β M . This pattern will be explained when we address the 3-factor model.
We also observe a slight inverted U-shape in these coefficients, which can explain the invert U-shape previously observed in CAPM beta’s. This suggests that the middle deciles are more dominated by small caps than the most and least efficient deciles.
Results for the CAPM and Fama-French 3-factor model have not been reported for the sake of brevity, but are available from the authors on request.
Results for the CAPM and Fama-French 3-factor model have not been reported for the sake of brevity, but are available from the authors on request.
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Frijns, B., Margaritis, D. & Psillaki, M. Firm efficiency and stock returns. J Prod Anal 37, 295–306 (2012). https://doi.org/10.1007/s11123-011-0246-y
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DOI: https://doi.org/10.1007/s11123-011-0246-y