Hostname: page-component-8448b6f56d-cfpbc Total loading time: 0 Render date: 2024-04-23T23:21:25.665Z Has data issue: false hasContentIssue false
  • English
  • Français

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)
Get access Rights & Permissions [Opens in a new window]

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.

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

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

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.

References

Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 1–32.CrossRefGoogle Scholar
Bernard, V. L., and Thomas, J. K.. “Evidence that Stock Prices Do Not Fully Reflect the Implications of Current Earnings for Future Earnings.” Journal of Accounting and Economics, 13 (1990), 205–340.Google Scholar
Bessembinder, H.; Cooper, M.; and Zhang, F.. “Characteristic-Based Benchmark Returns and Corporate Events.” Review of Financial Studies, 32 (2019), 75–125.CrossRefGoogle Scholar
Biais, B., and Gollier, C.. “Trade Credit and Credit Rationing.” Review of Financial Studies, 10 (1997), 903–937.CrossRefGoogle Scholar
Billet, M. T.; Flannery, M. J.; and Garfinkel, J. A.. “Are Bank Loans Special? Evidence on the Post-Announcement Performance of Bank Borrowers.” Journal of Financial and Quantitative Analysis, 41 (2006), 733–751.CrossRefGoogle Scholar
Bradshaw, M.; Richardson, S.; and Sloan, R.. “The Relation between Corporate Financing Activities, Analysts’ Forecasts, and Stock Returns.” Journal of Accounting and Economics, 42 (2006), 53–85.CrossRefGoogle Scholar
Brennan, M.; Miksimovic, V.; and Zechner, J.. “Vendor Financing.” Journal of Finance, 43 (1988), 1127–1141.CrossRefGoogle Scholar
Cao, S. “Reexamining Growth Effects: Are All Types of Asset Growth the Same?” Contemporary Accounting Research, 33 (2016), 1518–1548.CrossRefGoogle Scholar
Carhart, M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Chan, K.; Chan, L.; Jegadeesh, N.; and Lakonishok, J.. “Earnings Quality and Stock Returns.” Journal of Business, 79 (2006), 1041–1082.CrossRefGoogle Scholar
Cochrane, J. H.. “Production-Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations.” Journal of Finance, 46 (1991), 209–237.CrossRefGoogle Scholar
Cochrane, J. H. “A Cross-Sectional Test of an Investment-Based Asset Pricing Model.” Journal of Political Economy, 104 (1996), 572–621.CrossRefGoogle Scholar
Cohen, L., and Frazzini, A.. “Economic Links and Predictable Returns.” Journal of Finance, 63 (2008), 1977–2011.CrossRefGoogle Scholar
Cooper, M.; Gulen, H.; and Schill, M.. “Asset Growth and the Cross-Section of Stock Returns.” Journal of Finance, 63 (2008), 1609–1651.CrossRefGoogle Scholar
DuCharme, L. L.; Malatesta, P. H.; and Sefcik, S. E.. “Earnings Management, Stock Issues, and Shareholder Lawsuits.” Journal of Financial Economics, 71 (2004), 27–49.CrossRefGoogle Scholar
Eberhart, A. C.; Maxwell, W. F.; and Siddique, A. R.. “An Examination of Long-Term Abnormal Stock Returns and Operating Performance Following R&D Increases.” Journal of Finance, 59 (2004), 623–650.CrossRefGoogle Scholar
Fairfield, P.; Whisenant, J. S.; and Yohn, T. L.. “Accrued Earnings and Growth: Implications for Future Profitability and Market Mispricing.” Accounting Review, 78 (2003), 353–371.CrossRefGoogle Scholar
Fama, E. “Market Efficiency, Long-Term Returns, and Behavioral Finance.” Journal of Financial Economics, 49 (1998), 283–306.CrossRefGoogle Scholar
Fama, E., and French, K.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.CrossRefGoogle Scholar
Fama, E., and French, K.. “Common Risk Factors in Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E., and French, K.. “Dissecting Anomalies.” Journal of Finance, 63 (2008), 1653–1678.CrossRefGoogle Scholar
Fama, E., and French, K.. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116 (2015), 1–22.CrossRefGoogle Scholar
Fama, E., and MacBeth, J.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
Gu, Z., and Jain, P. C.. “The Accrual Anomaly and Operating Cash Flows: Evidence from Accrual Components.” Available at https://ssrn.com/abstract=892250 (2011).CrossRefGoogle Scholar
Hirshleifer, D.; Hou, K.; Teoh, S. H.; and Zhang, Y.. “Do Investors Overvalue Firms with Bloated Balance Sheets?” Journal of Accounting and Economics, 38 (2004), 297–331.CrossRefGoogle Scholar
Hui, K. W.; Klasa, S.; and Yeung, P. E.. “Corporate Suppliers and Customers and Accounting Conservatism.” Journal of Accounting and Economics, 53 (2012), 115–135.CrossRefGoogle Scholar
Ikenberry, D.; Lakonishok, J.; and Vermaelen, T.. “Market Underreaction to Open Market Share Repurchases.” Journal of Financial Economics, 39 (1995), 181–208.CrossRefGoogle Scholar
Ikenberry, D., and Ramnath, S.. “Underreaction to Self-Selected News Events: The Case of Stock Splits.” Review of Financial Studies, 15 (2002), 489–526.CrossRefGoogle Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.CrossRefGoogle Scholar
Jensen, M. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, 76 (1986), 323–329.Google Scholar
Jiang, X. “Beating Earnings Benchmarks and the Cost of Debt.” Accounting Review, 83 (2008), 377–416.CrossRefGoogle Scholar
Kim, Y., and Park, M. S.. “Pricing of Seasoned Equity Offers and Earnings Management.” Journal of Financial and Quantitative Analysis, 40 (2005), 435–463.CrossRefGoogle Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance, 49 (1994), 1541–1578.Google Scholar
Lam, F. Y. E. C, and Wei, K. C. J.. “Limits-to-Arbitrage, Investment Frictions, and the Asset Growth Anomaly.” Journal of Financial Economics, 102 (2011), 127–149.CrossRefGoogle Scholar
Lewellen, J. “The Cross-Section of Expected Stock Returns.” Critical Finance Review, 4 (2015), 1–44.Google Scholar
Li, D., and Zhang, L.. “Does q-Theory with Investment Frictions Explain Anomalies in the Cross Section of Returns?” Journal of Financial Economics, 98 (2010), 297–314.CrossRefGoogle Scholar
Li, X. N.; Livdan, D.; and Zhang, L.. “Anomalies.” Review of Financial Studies, 22 (2009), 4301–4334.CrossRefGoogle Scholar
Liu, L.; Whited, T. M.; and Zhang, L.. “Investment-Based Expected Stock Returns.” Journal of Political Economy, 117 (2009), 1105–1139.CrossRefGoogle Scholar
Liu, Y.; Ning, Y.; and Davidson, W. N.. “Earnings Management Surrounding New Debt Issues.” Financial Review, 45 (2010), 659–681.CrossRefGoogle Scholar
Long, M.; Malitz, I.; and Ravid, S.. “Trade Credit, Quality Guarantees, and Product Marketability.” Financial Management, 22 (1993), 117–127.CrossRefGoogle Scholar
Loughran, T., and Ritter, J.. “The Operating Performance of Firms Conducting Seasoned Equity Offerings.” Journal of Finance, 52 (1997), 1823–1850.CrossRefGoogle Scholar
Loughran, T., and Ritter, J.. “Why Has IPO Underpricing Changed over Time?” Financial Management, 33 (2004), 5–37.Google Scholar
Lyandres, E.; Sun, L.; and Zhang, L.. “The New Issues Puzzle: Testing the Investment-Based Explanation.” Review of Financial Studies, 21 (2008), 2825–2855.CrossRefGoogle Scholar
Mian, S. L., and Smith, C. W.. “Accounts Receivable Management Policy: Theory and Evidence.” Journal of Finance, 47 (1992), 169–200.CrossRefGoogle Scholar
Michaely, R; Thaler, R.; and Womack, K., “Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift?” Journal of Finance, 50 (1995), 573–608.CrossRefGoogle Scholar
Novy-Marx, R. “The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics, 108 (2013), 1–28.Google Scholar
Petersen, M., and Rajan, R.. “Trade Credit: Theories and Evidence.” Review of Financial Studies, 10 (1997), 661–691.CrossRefGoogle Scholar
Richardson, S. A.; Sloan, R. G.; Soliman, M. T.; and Tuna, I.. “Accrual Reliability, Earnings Persistence and Stock Prices.” Journal of Accounting and Economics, 39 (2005), 437–485.CrossRefGoogle Scholar
Ritter, J. R. “The Long-Run Performance of Initial Public Offerings.” Journal of Finance, 46 (1991), 3–27.CrossRefGoogle Scholar
Sloan, R. “Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?” Accounting Review, 71 (1996), 289–315.Google Scholar
Spiess, D. K., and Affleck-Graves, J.. “The Long-Run Performance of Stock Returns Following Debt Offerings.” Journal of Financial Economics, 54 (1999), 45–73.CrossRefGoogle Scholar
Stambaugh, R. F., and Yuan, Y.. “Mispricing Factors.” Review of Financial Studies, 30 (2017), 1270–1315.CrossRefGoogle Scholar
Teoh, S. H.; Welch, I.; and Wong, T. J.. “Earnings Management and the Underperformance of Seasoned Equity Offerings.” Journal of Financial Economics, 50 (1998a), 63–99.CrossRefGoogle Scholar
Teoh, S. H.; Welch, I.; and Wong, T. J.. “Earning Management and the Long-Run Market Performance of Initial Public Offerings.” Journal of Finance, 53 (1998b), 1935–1974.CrossRefGoogle Scholar
Titman, S.; Wei, K. C. J.; and Xie, F.. “Capital Investments and Stock Returns.” Journal of Financial and Quantitative Analysis, 39 (2004), 677–700.CrossRefGoogle Scholar
Titman, S.; Wei, K. C. J.; and Xie, F.. “Market Development and the Asset Growth Effect: International Evidence.” Journal of Financial and Quantitative Analysis, 48 (2013), 1405–1432.CrossRefGoogle Scholar
Watanabe, A.; Xu, Y.; Yao, T.; and Yu, T.. “The Asset Growth Effect: Insights from International Equity Markets.” Journal of Financial Economics, 108 (2013), 529–563.CrossRefGoogle Scholar