The Great Divorce Between Investment and Profitability

82 Pages Posted: 24 Sep 2019 Last revised: 14 Oct 2019

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: September 3, 2019

Abstract

We study the cross-sectional relation between investment, profitability, and equity returns over the last century. We document that high-profit firms invest more than low-profit firms before the late 1970s but invest less than low-profit firms afterwards. This reversal coincides with the emergence of the investment and profitability asset pricing factors and a corresponding reversal in the two factors' correlation. We link these changes to decreased long-term discount rates, which we document in the data. We develop a model where firms invest in short- and long-term projects. Responding to low discount rates, firms invest more in long-term projects, leading to high investment from low-profit firms and high average factor returns, as we observe in recent decades. The influx of long-term focused firms following the rise of venture capital in the late 1970s may explain the divorce between investment and profitability.

Keywords: Investment, Profitability, Cash Flow Duration, Long-Term, CMA Factor, RMW Factor, Venture Capital

JEL Classification: G12, G31, G24, D92

Suggested Citation

Kilic, Mete and Yang, Louis and Zhang, Miao Ben, The Great Divorce Between Investment and Profitability (September 3, 2019). 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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