An Evaluation of Chinese Firms’ Profitability: 2005-2013

48 Pages Posted: 22 Jan 2013 Last revised: 17 Oct 2014

See all articles by Jing Liu

Jing Liu

The Cheung Kong Graduate School of Business

James A. Ohlson

Hong Kong Polytechnic University - School of Accounting and Finance

Weining Zhang

Cheung Kong Graduate School of Business

Date Written: September 2014

Abstract

We empirically examine the profitability of leading Chinese firms, benchmarked against comparable US firms, for the period 2005-13. Return on invested capital (ROIC), which excludes leverage effects on performance, provides the primary metric. Averaged over firms and years, the two sets of firms have similar profitability, about 11% annually. Decomposing ROIC into free cash flow yield and invested capital growth, we show that the same ROIC has very different compositions: while the Chinese firms had high growth and negative free cash flows, the US firms had low growth and positive free cash flows. Due to balance sheet conservatism, we infer that Chinese (US) firms’ free cash flow yields and the resulting ROICs have been biased downwards (upwards). After correcting for the bias, we show that Chinese firms have much higher profitability than their US counterparts: 15.1% versus 8.1%. This result is driven by the abundance of growth opportunities in China in our sample period. When we control for the growth rates, we find US firms have been more “efficient” in generating more free cash flows than Chinese firms.

Keywords: profitability, conservatism, free cash flow, invested capital

Suggested Citation

Liu, Jing and Ohlson, James A. and Zhang, Weining, An Evaluation of Chinese Firms’ Profitability: 2005-2013 (September 2014). Available at SSRN: https://ssrn.com/abstract=2204872 or http://dx.doi.org/10.2139/ssrn.2204872

Jing Liu

The Cheung Kong Graduate School of Business ( email )

1 East Changan Avenue, Oriental Plaza
E3/3F
Beijing
China

James A. Ohlson (Contact Author)

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

Weining Zhang

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

HOME PAGE: http://english.ckgsb.edu.cn/FacultyResearch/Faculty/Accounting/ZhangWeining.aspx

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