The effect of customer concentration on stock sentiment risk

Abstract

The impact of stock sentiment risk on their returns has been well documented in literature, but exploration into the determinants of stock sentiment risk is lacking. We theorize that concentrated customer bases help mitigate stock sentiment risk. Empirical results based on a large sample from the U.S. market strongly support this hypothesis. Specifically, the mitigating effect takes place through three channels. Companies with high customer concentration tend to have better performance and information quality and attract more long-horizon institutional investors. All these factors contribute to diminishing stock sentiment risk. The results are robust when the endogeneity concern is addressed by investigating the effect of an exogenous shock, or when they are examined with alternative measures of sentiment risk. The negative relationship between customer concentration and stock sentiment risk is ubiquitous but even stronger during the 2008 financial crisis.

Appendix A: description of main variables

Variable name	Description
$\beta^{ST4}$	Sentiment beta of stocks obtained from Carhart four-factor model, following Baker and Wurgler (2006)
$\beta^{ST1}$	Sentiment beta of stocks obtained from market single-factor model (CAPM)
$\beta^{ST3}$	Sentiment beta of stocks obtained from Fama–French there-factor model
$\beta^{CCI}$	Sentiment beta of stocks based on Consumer Confidence Index (CCI), following Keiber and Samyschew (2019)
Concus	HHI ratio of Customer Concentration as defined in Patatoukas (2012)
InstTO	Institutional investor turnover as proposed by Gaspar et al. (2005)
Audit_fee	Audit fees in $US thousands from Audit Analytics
Total_fee	The sum of audit and audit-related fees in $US thousands from Audit Analyticsa
Restatement	An indicator variable for restatements of previously audited financial statementsb
Leverage	The ratio of total debt divided by total asset
mtb	The ratio of the market value of equity to the book value of equity measured at the beginning of the fiscal year
ppe	The ratio of net PP&E to the total asset
Cash	The ratio of cash and all securities readily transferable to cash as listed in the Current Asset section to the total assets
cf_na	The ratio of the Operating Income Before Depreciation (OIBDP) to non-current assets
nwc_na	The working capital minus cash and short-term investments, divided by the non-current assets
Capex	The ratio of capital expenditures to non-current assets
rd	Research and development expenditure divided by total assets
Log_at	The natural log of total assets
inst_ratio	Institutional ownership, defined as the equity held by institutional investors at the end of the last quarter in fiscal year t
lnage	The natural log of the number of years since IPO
roa	The return-on-assets calculated as the ratio of operating income after depreciation divided by total assets
sg	The annual percentage of growth rate in sales
Loss	An indicator variable for negative operating income after depreciationc
Debtmaturity	The ratio of short-term debt to total debt
Foreign	An indicator variable for foreign income or foreign income taxesd
△csale	The year-over-year growth in cash sales, where cash sales is calculated as sales minus the change in accounts receivables
△roa	The year-over-year change in return-on-assets
Soft	The ratio of total assets minus net PP&E minus cash and cash equivalents divided by total assets
gp	The firm’s gross profitability as revenues minus cost of goods sold, scaled by total assets following Novy-Marx (2013)
Ebitda	Earnings before interest, tax, depreciation and amortization scaled by the market value of equity
∆sale	Sales growth from year t to year t + 1
cfvol	The annualized standard deviation of cash flow in 5 years

1. ^aAudit-related fees are assurance and related services that traditionally are performed by the independent accountant and include employee benefit plan audits, due diligence related to mergers and acquisitions, accounting consultations and audits in connection with acquisitions, internal control reviews, attest services that are not required by statute or regulation, and consultation concerning financial accounting and reporting standards
2. ^bIndicator variable = 1 for financial statement restatements not attributed to clericala errors identified by Audit Analytics, 0 otherwise
3. ^cIndicator variable = 1 if operating income after depreciation is negative, 0 otherwise.
4. ^dIndicator variable = 1 if the firm reports foreign income or foreign income taxes, 0 otherwise.