Changes in Operational Efficiency and Firm Performance: A Frontier Analysis Approach

53 Pages Posted: 23 Sep 2010

See all articles by Bok Baik

Bok Baik

Seoul National University

Joon Chae

Seoul National University

Sunhwa Choi

Sungkyunkwan University

David B. Farber

Indiana University Kelley School of Business Indianapolis

Date Written: September 23, 2010

Abstract

This study examines whether changes in operational efficiency predict firm performance. Using measures based on frontier analysis as our proxies for operational efficiency, we find that changes in efficiency are positively associated with changes in current and future earnings. We also find a positive relation between efficiency changes and contemporaneous stock returns, implying that investors find the information in efficiency changes to be value relevant. However, we also show that efficiency changes predict future stock returns, suggesting that market participants do not fully incorporate the predictive power of changes in efficiency for future changes in profitability. Finally, we show that our measures of operational efficiency changes are positively associated with analyst forecast revisions, but not associated with analyst forecast errors; these results suggest that analysts have a deep understanding of firms’ efficiency. Importantly, our results hold even after controlling for fundamental signals and changes in asset turnover, a commonly used proxy for operational efficiency. Overall, our study provides evidence suggesting that measures of operational efficiency derived from frontier analysis have predictive power incremental to simple financial ratios. Results from our study therefore have implications for fundamental analysis.

Keywords: Operational efficiency, Data Envelopment Analysis, Stochastic Frontier Analysis, Fundamental Analysis

JEL Classification: M41

Suggested Citation

Baik, Bok and Chae, Joon and Choi, Sunhwa and Farber, David B., Changes in Operational Efficiency and Firm Performance: A Frontier Analysis Approach (September 23, 2010). Available at SSRN: https://ssrn.com/abstract=1681748 or http://dx.doi.org/10.2139/ssrn.1681748

Bok Baik (Contact Author)

Seoul National University ( email )

Seoul
Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

Joon Chae

Seoul National University ( email )

Seoul, 151-742
Korea, Republic of (South Korea)
82-2-880-6929 (Phone)
82-2-882-0547 (Fax)

Sunhwa Choi

Sungkyunkwan University ( email )

Sunkyunkwan University Business School
25-2, Sungkyunkwan-ro, Jongno-gu
Seoul, 03063
Korea, Republic of (South Korea)

David B. Farber

Indiana University Kelley School of Business Indianapolis ( email )

801 W Michigan Ave
Indianapolis, IN 46202
United States

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