The Limitations of Industry Concentration Measures Constructed with Compustat Data: Implications for Finance Research

Abstract

Industry concentration measures calculated with Compustat data, which cover only the public firms in an industry, are poor proxies of actual industry concentration. These measures have correlations of only 13 percent with the corresponding U.S. Census measures, which are based on all public and private firms in an industry. Also, only when U.S. Census measures are used is there evidence consistent with theoretical predictions that more concentrated industries, which should be more oligopolistic, are populated by larger and fewer firms with higher price-cost margins. Further, the significant relations of Compustat based industry concentration measures with the dependent variables of several important prior studies are not obtained when U.S. Census measures are used. One of the reasons for this occurrence is that Compustat based measures proxy for industry decline. Overall, our results indicate that product markets research that uses Compustat based industry concentration measures may lead to incorrect conclusions.

Keywords: Industry concentration, product market competition, finance research

JEL Classification: G12, L10