Changes in Operational Efficiency and Firm Performance: A Frontier Analysis Approach
53 Pages Posted: 23 Sep 2010
Date Written: September 23, 2010
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: Suggested Citation