Corporate Market Investments: Risk and Governance

Abstract

This paper studies the risk associated with corporate market investments. For the years 1970 to 2011, market investment returns are shown to be risky and inefficient. The value-weighted average firm-level portfolio risk is 60%; the Sharpe ratio is merely 4.7%. Using a novel fiscal-year factor pricing approach, I show that the market beta for all firms is 27%. Portfolio cash-flow risk relative to assets is comparable to operating cash-flow risk, and market investment returns substitute for accounting manipulation. Moreover, market investment risk decreases with institutional ownership. The findings suggest that market investment risk is substantial and associated with agency costs.