Growth Expectations, Excess Value, and the Risk-Adjusted Return to Market Power

Abstract

Differences in the equilibrium cost of capital attributable to differences in risk have long been suspected of invalidating traditional comparisons of the accounting return on capital across market structures [25; 20; 11; 23; 7; 18]. And numerous previous attempts to measure the structure-performance effects of large market share and high concentration may have been confounded by other limitations of book profitability as a measure of economic performance [13; 8]. To address these inherent weaknesses in traditional structureperformance research a promising new approach has related several elements of market structure - including market share, advertising intensity, and concentration - to the capitalized value of anticipated stockholder returns [27; 28; 17; 18; 16; 12; 13; 14; 2]. Assuming efficient capital markets, capitalized value should capture all the relevant information concerning the firm's economic profitability including forward-looking, expectational information not available from accounting data alone. Moreover, asset pricing models provide a theoretical framework from which to derive testable relationships between market power and risk-adjusted economic performance. Modeling the asset valuation of a firm's income-earning potential enunciates an explicit role for non-diversifiable risks. And by removing the equilibrium return on or valuation of the firm's tangible assets from its observed return or valuation, these value-based tests are capable of generating riskadjusted comparisons of economic rent across market structures. Yet, there has been an inadequate treatment of risk (especially expectational risk) in the previous literature, and several inconsistent and anomalous results may be attributable to this deficiency. Lindenberg and Ross (LR) found four-firm concentration unrelated to Tobin's q (i.e., capitalized value/ replacement cost) for a large sample of Fortune 1000 manufacturing firms [16]; however, LR omitted risk from their model altogether. Hirschey's studies of relative excess value (i.e., capitalized value-book value) per dollar sales, (V - B)/S, controlled for an ex post measure of non-diversifiable risk (i.e., Value Line