Can Global Sourcing Strategy Predict Stock Returns?

Abstract

Problem definition: While firms are increasingly relying on sourcing globally as a key constitute of their supply chain strategy, there is no empirical evidence on whether investors of these firms adequately reflect firms' global sourcing strategy (GSS) in their stock valuation process. In this paper, we empirically test whether stock market participants are efficient in doing so.

Methodology/results: Using the empirical asset pricing framework, we find that information concerning firms' GSS strongly predicts their future stock returns. We compile a transaction-level imports database for US-listed firms and construct measures for five different aspects of their global sourcing strategies: the extent of global sourcing; supplier relationship strength; supplier concentration; sourcing lead time; and sourcing countries' logistical efficiency. For each measure, we examine returns of a zero-cost investment strategy of buying from the highest and selling from the lowest quintile of that measure. Collectively these investment strategies yield an average annual four-factor alpha of 6% to 9.6% (6% to 13.9%) with value (equal)-weighted portfolios. Their return predictability is incremental over other operations-motivated predictors such as inventory turnover and cash conversion cycle, is persistent across different supply chain positions, and is robust to alternate risk models, subsamples, and empirical specifications. Together, our results indicate that the GSS measures embody independent information about firms' future profitability, and this information is mispriced by market participants, leading to predictable returns. In accordance with this mechanism, we find that the GSS measures strongly predict both firms' future earnings and the surprise in market reactions around the earnings announcement days.

Managerial implications: The robust return predictability of our GSS measures suggests that investors are not fully incorporating GSS-related information in their stock valuation frameworks. Therefore, our results calls for greater investor education on global sourcing and better dissemination of global sourcing information so as to mitigate valuation inefficiency.

Keywords: sourcing strategies, global sourcing, asset pricing, empirical operations management