Firm Profitability: Mean-Reverting or Random-Walk Behavior?

36 Pages Posted: 7 Apr 2012 Last revised: 29 May 2014

See all articles by Giorgio Canarella

Giorgio Canarella

California State University, Los Angeles - Department of Economics & Statistics; University of Nevada, Las Vegas

Stephen M. Miller

University of Nevada, Las Vegas - Department of Economics; University of Connecticut - Department of Economics

Mahmoud M. Nourayi

Loyola Marymount University - Department of Accounting

Date Written: February 24, 2012

Abstract

We analyze the stochastic properties of three measures of profitability, return on assets (ROA), return on equity (ROE), and return on investment (ROI), using a balanced panel of US firms during the period 2001-2010. We employ a panel unit-root approach, which assists in identifying competitive outcomes versus situations that require regulatory intervention to achieve more competitive outcomes. Based upon conventional panel unit-root tests, we find substantial evidence supporting mean-reversion, which, in turn, lends support to the long-standing “competitive environment” hypothesis originally set forward by Mueller (1976). These results, however, prove contaminated by the assumption of cross-sectional independence. After controlling for cross-sectional dependence, we find that profitability persists indefinitely across some sectors in the US economy. These sectors experience extremely slow, or non-existent, mean-reversion.

Keywords: Cross-sectional dependence, unit roots, panel data, hysteresis, firm profitability

JEL Classification: C23, D22, L25

Suggested Citation

Canarella, Giorgio and Miller, Stephen M. and Nourayi, Mahmoud M., Firm Profitability: Mean-Reverting or Random-Walk Behavior? (February 24, 2012). Journal of Economics and Business, March-April 2013. Available at SSRN: https://ssrn.com/abstract=2010816 or http://dx.doi.org/10.2139/ssrn.2010816

Giorgio Canarella

California State University, Los Angeles - Department of Economics & Statistics ( email )

Los Angeles
Los Angeles, CA 90032
United States

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

Stephen M. Miller (Contact Author)

University of Nevada, Las Vegas - Department of Economics ( email )

4505 S. Maryland Parkway
Box 456005
Las Vegas, NV 89154
United States
702-895-3776 (Phone)
702-895-1354 (Fax)

HOME PAGE: http://faculty.unlv.edu/smiller/

University of Connecticut - Department of Economics

365 Fairfield Way, U-1063
Storrs, CT 06269-1063
United States

Mahmoud M. Nourayi

Loyola Marymount University - Department of Accounting ( email )

One LMU Dr.
Hilton 317
Los Angeles, CA 90045
United States

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