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Skin in the Game: Operating Growth, Firm Performance, and Future Stock Returns

Published online by Cambridge University Press:  11 July 2022

Sean Shun Cao ,
Zhe Wang  and
P. Eric Yeung Open the ORCID record for P. Eric Yeung [Opens in a new window]
Sean Shun Cao
Affiliation:
University of Maryland Robert H. Smith School of Businessscao824@umd.edu
Zhe Wang
Affiliation:
Nankai University Business Schoolwangzheustc@outlook.com
P. Eric Yeung*
Affiliation:
Cornell University Johnson Graduate School of Management
*
eric.yeung@cornell.edu (corresponding author)
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Abstract

Prior research documents that asset growth is negatively associated with future firm performance. In contrast, we show that growth financed by product market stakeholders (i.e., “operating growth”) is positively associated with future firm performance. Investors and security analysts underestimate the positive effects of operating growth on future performance, resulting in return predictability and overly pessimistic earnings forecasts for firms with high operating growth. Future stock returns largely concentrate around subsequent earnings announcements with declining magnitudes, consistent with the error-in-expectation explanation. Results from cross-sectional tests further support the hypothesis that operating growth signals high future performance but investors underreact to it.

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Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 7 , November 2022 , pp. 2559 - 2590
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We are grateful for helpful comments from Vikas Agarwal, Hendrik Bessembinder (the editor), Michael Cooper (the referee), David McLean, Siew Hong Teoh, Teri Yohn, conference and workshop participants, and conference discussants at the 2019 China International Conference in Finance; 2019 MFA Annual Meeting; Temple Accounting 100th Anniversary Conference (2018); the 2018 Australian Finance and Banking Conference; the 2019 AAA Financial Accounting and Reporting Section Mid-Year Meeting; Cornell University; Georgia State University; and Southwest Jiaotong University.

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