Skin in the Game: Operating Growth, Firm Performance, and Future Stock Returns
Forthcoming, Journal of Financial and Quantitative Analysis
47 Pages Posted: 16 Feb 2021 Last revised: 10 Mar 2021
Date Written: February 15, 2021
Abstract
Prior research documents that asset growth is negatively associated with future firm performance. In contrast, we show that growth financed by product market stakeholders (i.e., “operating growth”) is positively associated with future firm performance. Investors and security analysts under-estimate the positive effects of operating growth on future performance, resulting in return predictability and overly pessimistic earnings forecasts for firms with high operating growth. Future stock returns largely concentrate around subsequent earnings announcements with declining magnitudes, consistent with the error-in-expectation explanation. Results from cross-sectional tests further support the hypothesis that operating growth signals high future performance but investors underreact to it.
JEL Classification: G12; G14; G15
Suggested Citation: Suggested Citation
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