The Great Divorce Between Investment and Profitability: A Duration-Based Explanation

68 Pages Posted: 24 Sep 2019 Last revised: 13 Jul 2020

See all articles by Mete Kilic

Mete Kilic

University of Southern California - Marshall School of Business

Louis Yang

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Miao Ben Zhang

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: July 10, 2020

Abstract

We document novel facts about the U.S. stock market during the past forty years which show opposing characteristics to the prior decades: A negative cross-sectional correlation between firms' investment and profitability, and strong premia of investment and profitability factors which are positively correlated. A model of firms with heterogeneous cash flow duration explains these findings: Firms with higher duration have lower discount rates, leading them to invest more despite having lower current profitability. An influx of high-duration firms boosted investment and profitability premia due to the duration premium. These nuances do not exist in countries where long-term investments are scarce.

Keywords: Cash Flow Duration, Cross-Section of Stock Returns, Investment Premium, Profitability Premium, Duration Premium, Long-Term Investments, Venture Capital

JEL Classification: G10, G12, G31, G24, D92

Suggested Citation

Kilic, Mete and Yang, Louis and Zhang, Miao Ben, The Great Divorce Between Investment and Profitability: A Duration-Based Explanation (July 10, 2020). Available at SSRN: https://ssrn.com/abstract=3447685 or http://dx.doi.org/10.2139/ssrn.3447685

Mete Kilic

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Louis Yang

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Miao Ben Zhang (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

HOME PAGE: http://www.MiaoBenZhang.com/

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