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Firm profitability: Mean-reverting or random-walk behavior?

  • Canarella, Giorgio
  • Miller, Stephen M.
  • Nourayi, Mahmoud M.

We analyze the stochastic properties of three measures of profitability, return on assets (ROA), return on equity (ROE), and return on investment (ROI), using a balanced panel of US firms during the period 2001–2010. We employ a panel unit-root approach, which assists in identifying competitive outcomes versus situations that require regulatory intervention to achieve more competitive outcomes. Based upon conventional panel unit-root tests, we find substantial evidence supporting mean-reversion, which, in turn, lends support to the long-standing “competitive environment” hypothesis originally set forward by Mueller (1977). These results, however, prove contaminated by the assumption of cross-section independence. After controlling for cross-section dependence, we find that profitability evolves as a non-stationary process in some sectors in the US economy. Our findings, especially taken as a whole, remain fairly robust to various assumptions regarding the underlying data generation process.

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Article provided by Elsevier in its journal Journal of Economics and Business.

Volume (Year): 66 (2013)
Issue (Month): C ()
Pages: 76-97

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Handle: RePEc:eee:jebusi:v:66:y:2013:i:c:p:76-97
Contact details of provider: Web page: http://www.elsevier.com/locate/jeconbus

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