Firm-specific Components Research Articles

Factors affecting corporate cash holdings: Evidence from the energy sector of Saudi Arabia

This study investigates the impact of firm-specific components of cash holdings on the cash reserves of energy firms. Decisions related to cash management are significant and treated as confident made by financial managers to increase the value of a firm. Therefore, financial managers are obligated to hold an optimum level of cash to enhance the firm value. The study depends on secondary data from seven energy firms listed on the Saudi Arabian Stock Exchange over the period between 2014 and 2023. The study considers cash holdings as a dependent variable, leverage, networking capital, and profitability as explanatory variables, and firm size as a control variable. The study employed a linear regression model and a generalized linear regression (GLM) model with Gaussian and Gamma distributions to analyze the data. The results show that Saudi Arabian energy firms reserve approximately 7% of cash, while external financing is 51%. The pooled regression results show that the association between leverage and firms’ cash reserves was negative (–0.064) and significant at less than a 1% significance level. Further, the networking capital and profitability were positively related (0.063 and 0.113) and significant at 5% and 1% significance levels. Moreover, the firm size was positive but insignificant. The generalized linear regression model results with Gaussian and Gamma distributions were similar to the simple linear regression with minor variation. AcknowledgmentThis current project under research project number PSAU/2023/02/25767 was funded by Prince Sattam Bin Abdulaziz University.

Institution, Major, and Firm-Specific Premia: Evidence from Administrative Data

We examine how a student’s field of degree and institution attended contribute to the labor market outcomes of young graduates. Administrative panel data that combines student transcripts with matched employer-employee records allow us to provide the first decomposition of premia into individual and firm-specific components. We find that both major and institutional premia are more strongly related to the firm-specific component of wages than the individual-specific component of wages. On average, a student’s major is a more important predictor of future wages than the selectivity of the institution attended, but major premia (and their relative ranking) can differ substantially across institutions, suggesting the importance of program-level data for prospective students and their parents.

Wall street watches Washington: Asset pricing implications of policy uncertainty

We examine the effect of economic policy uncertainty (EPU) on sell-side analysts’ forecasts, the allocation of attention, and the stock market reaction to earnings news. We find that periods of high EPU are associated with higher analyst disagreement and a decrease in forecast accuracy. Specifically, we show that analysts issue on average more pessimistic forecasts when EPU is high. Second, we show that higher levels of EPU are associated with higher attention to the overall stock market and lower firm-level attention, in line with category learning behavior. Forecast errors also have a larger firm-specific component during periods of high EPU. Finally, we show that the trading volume and price responses to earnings announcements hardly depend on EPU. Hence, investors tend to follow analyst forecasts, thereby failing to incorporate a predictable bias.

Is Sector Neutrality in Factor Investing a Mistake?

Stock characteristics have two sources of predictive power. First, a characteristic might be valuable in identifying high or low expected returns across industries. Second, a characteristic might be useful in identifying individual stock expected returns within an industry. Past studies generally find that the firm-specific component is the strongest predictor, leading many to sector neutralize their factor exposures. We show both analytically and empirically that the average long–short investor is more likely to benefit from hedging out sector bets, whereas the long-only investor should, on average, avoid sector neutralization.

Investor base, cost of capital, and new listings on the NYSE

Investor base, cost of capital, and new listings on the NYSE

Contrarian Profits and the Overreaction Hypothesis: The Case of the Athens Stock Exchange

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.

How Completely Do Analysts Incorporate Firm-Specific and Industry Information in Their Forecasts? Evidence and Implications for Post-Forecast Revision Drift

Prior studies find a positive relation between analyst forecast revisions and upcoming news, suggesting that analysts’ forecast revisions are incomplete with respect to available information. In this study, we use the association between forecast revisions and upcoming news to measure forecast completeness and show that post-forecast-revision drift is higher when forecasts are incomplete. We follow Hui and Yeung’s (2013) approach to separate forecast revision news into industry-wide and firm-specific components because they find that drift is primarily associated with the industry component. We find that forecast revisions are less complete for industry-wide news than for firm-specific news. Furthermore, analysts’ industry-wide revisions are less complete early in the year and when the underlying news is bad, and we find stronger post-forecast-revision drift in those cases. We also show that analysts who were optimistic in prior periods tend to issue forecasts that are less complete and that generate stronger drift than forecasts by other analysts. Our findings provide an explanation for the drift that contrasts with prior studies that attribute the drift to investors’ slow assimilation of the news in forecast revisions. Thus, our study sheds light on analysts’ role in conveying firm-specific and industry-wide news to investors and on the implications for post-forecast-revision drift.

Is sector-neutrality in factor investing a mistake?

Stock characteristics have two sources of predictive power. First, a characteristic might be valuable in identifying high or low expected returns across industries. Second, a characteristic might be useful in identifying individual stock expected returns within an industry. Past studies generally find that the firm-specific component is the strongest predictor, leading many to sector neutralize their factor exposures. We show that this problem is equivalent to the classic two risky-asset problem and derive the condition that decides when the sector component of a characteristic should be omitted. We show both analytically and empirically that the long–short investor is more likely to benefit from hedging out sector bets, whereas the long-only investor is more likely to benefit from investing in the factor as it stands.

Modelling Sector-Level Asset Prices

We present a modelling approach for sector asset pricing studies that incorporates sector-level risk factors, subgroup portfolios, and structural breakpoint tests that are better at isolating the time-varying nature and the firm-specific component of returns. Our results show considerable subsector heterogeneity, while the asset pricing model using local risk factors and inductive structural breaks results in a superior model ( R 2 of 80.42% relative to R 2 of 68.79% of “conventional” models). Finally, we show that some of the variances of residuals, normally assumed to be the firm-specific component of returns, can be attributed to the changing relationship between sector returns and risk factors.

The Role of Competitive Amplification in Explaining Sustained Performance Heterogeneity

This paper presents a formal model that elucidates how sustained performance heterogeneity emerges from competitive amplification due to endogenous resource investment under uncertainty. Specifically, the model shows that if resources are scale free, any small resource differences are amplified into large performance differences, leading to high firm-specific heterogeneity in an industry, and vice versa for resources with low scalability. This finding provides a theoretical explanation for the empirical observation that firm-specific components of performance heterogeneity in the variance decomposition studies are significantly larger in some sectors than in others. Consistent with the predictions of the model, the empirical analysis in this paper confirms that industries with more scale free resources on average exhibit higher firm-specific heterogeneity.

Contrarian profits of the firm-specific component on stock returns

A weekly contrarian strategy based on residual stock returns provides larger, more significant, and steadier profits than conventional contrarian strategies, which use total returns. We decompose residual return-based contrarian profits by modifying the decomposition methodology in Lo and MacKinlay (1990). This decomposition reveals that the residual return-based contrarian profits are attributed to negative autocovariances in individual residual returns, rather than positive cross-serial covariances across residual returns. We further decompose Lo and MacKinlay's decomposition, and reveal that winners are strongly negatively autocorrelated. In conclusion, investors' overreactions to good firm-specific news are a primary source of residual contrarian profits.

The Role of (De-)Centralized Wage Setting for Industry Dynamics and Economic Growth: An Agent-Based Analysis with the Eurace@Unibi Model

In this paper, we employ the agent-based macroeconomic Eurace@Unibi model to study the economic implications of different degrees of de-centralization in the wage setting. We think of de-centralization as wages being a weighted average of an economy-wide ‘union wage’ and a firm-specific component depending on the firm’s productivity and the experienced tightness of the labor market. Starting from a baseline scenario, corresponding to a high degree of unionization, in which wages are fully centralized and indexed on economy-wide productivity gains and inflation, we investigate how an increasing level of de-centralization affects the dynamics of output, employment, inequality, and market concentration. Our findings suggest that stronger centralization of the wage-setting process induces lower wage inequality and stronger concentration on the consumption goods market. Furthermore, due to more physical investments, an economy with more centralized wage setting is characterized by higher productivity and faster economic growth.

Total attention: The effect of macroeconomic news on market reaction to earnings news

Abstract We show evidence that consistent with category-learning behavior, investors allocate more attention to macroeconomic news than to firm-specific news, such as earnings announcements. Despite the distracting effect of macroeconomic news on investor attention, we find that earnings announcements with concurrent macroeconomic news announcements actually have significantly stronger immediate market response and weaker post-earnings announcement drift. We hypothesize that the combined total attention to macroeconomic news and earnings announcements helps investors understand both the systematic and firm-specific components of earnings surprises. Consistent with the hypothesis, our results show that the macroeconomic news effect is mainly driven by firms with high exposure to macroeconomic news. Moreover, we show that the effect is stronger when macroeconomic news contains more information and for firms with greater information uncertainty. Finally, we provide evidence that macroeconomic news helps reduce stock return uncertainty and enhance stock price efficiency.

Do open-market stock repurchases convey firm-specific or industry-wide information? Evidence from REITs

This study examines the extent of firm-specific and industry-level information conveyed in open-market stock repurchases announced by REITs. We measure information revealed in open-market stock repurchase announcements using stock return and decompose the stock return into firm-specific, industry-wide, and market components. We find that the announcement period return is mainly attributed to the firm-specific component. However, long-term returns following the announcement are largely due to the industry return components. We also find that changes in profitability are not related to the announcement abnormal return. Our results suggest that the repurchase signal is about the intrinsic value of a REIT rather than the REIT’s future prospect. Moreover, the repurchase signal is fully incorporated into the pricing process at the announcement.

Interactive Distraction: The Effect of Macroeconomic News on Market Reaction to Earnings News

We show evidence that consistent with category-learning behavior, investors allocate more attention to macroeconomic news than to firm-specific news, such as earnings announcements. Despite the distracting effect of macroeconomic news on investor attention, we find that earnings announcements with concurrent macroeconomic news announcements actually have significantly stronger immediate market response and weaker post-earnings announcement drift. We hypothesize that the combined total attention to macroeconomic news and earnings announcements helps investors understand both the systematic and firm-specific components of earnings surprises. Consistent with the hypothesis, our results show that the macroeconomic news effect is mainly driven by firms with high exposure to macroeconomic news. Moreover, we show that the effect is stronger when macroeconomic news contains more information and for firms with greater information uncertainty. Finally, we provide evidence that macroeconomic news helps reduce stock return uncertainty and enhance stock price efficiency.

How Do Firms Appropriate Value from Employees with Transferable Skills? A Study of the Appropriation Puzzle in Actively Managed Mutual Funds

How do firms benefit from employees with transferable skills? The prevailing view is that labor market frictions that impede employee mobility or strategies that constrain skill transferability are the primary instruments for firms to appropriate value from human capital. The empirical evidence, however, suggests that employees continue to be mobile, and firms pay premiums to attract and retain employees with transferable skills. To reconcile theory with data, we use data from the mutual fund industry, where it is widely documented that active fund managers appropriate more value than they generate. We develop a theory of positive externalities stemming from transferable human capital that we argue accrue mostly to the firm, and provide evidence of such externalities in the mutual fund context. Empirically, we decompose the skills of mutual fund managers into task- and firm-specific components and argue that managers with task-specific skills generate positive externalities at the firm level that are not reflected in their performance measured at the fund level. We advance and test empirical hypotheses on the existence of these positive unmeasured externalities by examining whether managers with task-specific skills are more likely to be associated with activities such as mentoring, increased risk taking, and generating spillovers at the firm level. Our results show that managers with task-specific skills are indeed associated with greater positive externalities, compared with managers with firm-specific skills. We discuss the implications of our results for the literature on human capital value creation and appropriation.The e-companion is available at https://doi.org/10.1287/orsc.2017.1197 .

Bidding in First Price Sealed Bid Common Value Auctions: A Computational Approach

Computational methods are used to analyze bidding in first price sealed bid auctions for abroad range of realistic scenarios. Bidders valuations may have both common value and firm-specific components, and the accuracy of their estimates of the common value component may differ. In addition, we allow for a subset of “naive” bidders, defined as bidders who do not account for the Winners’ Curse. Following Rothkopf (1969, 1980), Wilson (1984), and Compte and Postlewaite (2012), we obtain a constant Shading Factor that maximizes ex-ante expected profits. Our computations show that profit-maximizing shading is greatly impacted by asymmetries in the bidding population and, in particular, by the presence of naive bidders. Failing to account for the presence of naive bidders results in underbidding only in one case, when facing a single rival who is naive, and in overbidding in all other cases. Overbidding is particularly severe when the population of naive competitors is large.

The Role of Individual Firms in Aggregate Fluctuations: Evidence from Hungary

This paper investigates the role of activities by Hungarian firms in generating aggregate fluctuations for the time period 2000–2013. The paper decomposes aggregated sales volatility into a macro-sectoral and firm-specific component and finds that shocks to individual firms contribute significantly to aggregate fluctuations. The relative contribution of idiosyncratic shocks to sales volatility at the aggregate level is 55.5 per cent for the whole economy and 56.4 per cent for the manufacturing sector. The main mechanism through which firm fluctuations manifest themselves in aggregate fluctuations is input–output linkages.

Investment Decisions by European Firms and Financing Constraints

We reinvestigate the question of whether corporate investment during the financial crisis depended to a significant extent, and differently than in the pre-crisis period, on firms’ short-term liquidity and indebtedness. Using data on listed firms in the euro area and the United Kingdom, we employ a correlated random coefficient panel data model estimated with instrumental variables in order to address potential endogeneity concerns. First, we find that to attain plausible identification, we must allow for the possibility that the unobserved firm-specific component of investment changed with the onset of the financial crisis. Second, our results suggest that neither cash reserves nor short-term debt, considered separately, were significant determinants of investment. However, we do find evidence of a negative conditional dependence between corporate investment and short-term debt net of cash reserves.

Modelling Sector-Level Asset Prices

We present a modelling approach for sector asset pricing studies that incorporates sector-level risk factors, sub-group portfolios, and structural break point tests that are better at isolating the time-varying nature and the firm-specific component of returns. The sub-group portfolios show considerable subsector heterogeneity, while the asset pricing model using local risk factors and inductive structural breaks results in a superior model (R2 of 80.42% relative to R2 of 68.79% of ‘conventional’ models). Finally, we show that 28% of the variance of residuals, normally assumed to be the firm-specific component of returns, can be attributed to the changing relationship between sector returns and risk premia.