Structure and Performance with Profit Measures Based on Stock Market Prices

Abstract

The theory that there is a causal relationship between industry structure, conduct, and performance is the fundamental premise in the field of industrial organization. The most carefully researched component of that general theory is the hypothesis that increasing industrial concentration will give rise to increasing profits. This traditional view is important not only because of its prominence in the academic analysis of industrial markets, but also because of its implications for government policy, especially antitrust policy. The traditional view typically has been tested by treating an accounting-based measure of industry profit as the dependent variable, with concentration and other structural variables as independent variables within a cross-section of manufacturing industries at a given point in time. Numerous papers' have found that concentration has a positive impact on profits. The methodology adopted in this paper is different. The profit measures are based on stock market prices and are adjusted for risk. This is an improvement because accounting methods are so poorly adapted to the measurement of economic profit, and because risk may vary with concentration [2;39]. Another methodological innovation is the choice of time series over cross-section analysis. The question asked is whether the change over time in each industry's level of concentration had an impact on profits. This minimizes the problem of omitted or inaccurately measured independent variables, since there should be less change in basic structural characteristics over short time periods within an industry than between industries at a single point in time.2 A second important advantage is freedom from a basic assumption of crosssection studies-the assumption that the relationship between concentration and profit is homogeneous across industries. If the assumption is invalid, empirical results are subject to bias. Two tests [7;26] have firmly rejected the homogeneity assumption.3