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

69 Pages Posted: 24 Sep 2019 Last revised: 17 Jun 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: June 9, 2020

Abstract

We document novel facts in the U.S. stock market during the recent four decades which are in opposite 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: Investment, Profitability, 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 (June 9, 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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