Profit Persistence, Entry and Exit, Asset Prices.

The purpose of this study is to develop new methods in order to analyze the history of the largest 500 US companies of 1950 in terms of survival and profit persistence. In four sub-projects the pattern of profit persistence, its causes and determinants and finally its connection to the asset prices will be analyzed. Since both the profits and the asset prices of a company are of great interest to managers, potential investors, financial and theoretical economists this topic is of high relevance. The present methodology makes it possible to determine more precisely which industry or firm characteristics characterize a persistently profitable firm. Is it the ability of the firm to grow and to obtain a large market share or is it mainly the affiliation to a specific industry that makes a firm successful? Sub-project 1 will use a recently developed methodology in order to analyze the persistence of profits and its determinants. The impact of industry and firm characteristics upon profit persistence has been extensively analyzed before. However, in all previous studies, for each company or industry just one profit persistence measure for the whole time-span has been estimated. The present methodology allows for the profit persistence estimate to vary with time and therefore more robust estimates are expected. Sub-project 2 deals with one of the causes of profit persistence: entry and exit barriers. One form of entry and exit barriers are sunk costs. A "sunkness index" using depreciation rates as a proxy for sunk costs will be constructed and its impact on profitability and on entry and exit will be analyzed. Sub-project 3 applies the "classical methodology" used in the profit persistence literature in order to analyze the development of asset prices and their relationship to profits. As the stock price market is one of the most competitive markets, less persistence is expected for the abnormal stock returns than for abnormal profits. Finally sub-project 4 applies a recently developed "band width" methodology for profits in order to analyze the dynamic capital structure choice in the presence of recapitalization costs. Research collaborations with universities in the US and Austria are planned.

The purpose of this study was to analyse the history of the largest US companies in terms of survival and profit persistence. In four sub-projects the pattern of profit persistence, its causes and determinants and finally its connection to the asset prices were analysed. Since both the profits and the asset prices of a company are of great interest to managers, potential investors, financial and theoretical economists, the results of the present study are of high relevance. Sub-project 1 used a recently developed methodology in order to analyse the persistence of profits and its determinants. The impact of industry and firm characteristics upon profit persistence has been extensively analysed before. However, in all previous studies, for each company or industry just one profit persistence measure for the whole time-span has been estimated. The present methodology allows for the profit persistence estimate to vary with time and therefore more robust estimates have been obtained. For the largest US manufacturing companies the most important industry determinants of profit persistence have been found to be industry concentration and industry size. However, at firm level, market share and risk have surprisingly a negative impact on profit persistence.Sub-project 2 has applied the time varying methodology to the European food sector comparing results from 5 European Countries. The analysis reveals that the degree of profit persistence in the food industry is lower compared with other manufacturing sectors due to strong competition among food processors and high retailer concentration. Furthermore, firm size is an important driver of persistence, while firm age, risk and R&D intensity have a negative influence. One of the main conclusions of this analysis is that it is important to encourage and subsidize the right innovations that lead to success within the food sector, namely truly new product innovations and to help firms to reach a specific critical size in order to be able to counteract the market power of the retailers.Sub-project 3 deals with one of the main causes of profit persistence: entry and exit barriers. One form of entry and exit barrier would be sunk costs. A "sunkness index" using depreciation rates as a proxy for sunk costs was constructed and its impact on profitability and on entry and exit has been analysed. The paper confirms two of the most robust results from dynamic competitive models namely that firms in industries with higher sunk costs observe a higher volatility of their profitability and that they enter and exit these industries less than other industries. The paper also argues on theoretical and empirical grounds that depreciation generates countervailing results.Sub-project 4 applies the "classical methodology" used in the profit persistence literature in order to analyse the development of asset prices and their relationship to profits. As the stock price market is one of the most competitive markets, less persistence is obtained for the abnormal stock returns than for abnormal profits. It is shown that firm specific long-run profit persistence, after correction for other additional economic fundamentals of the firm, has a positive impact on adjusted returns and a negative impact on their volatility. Therefore, firms with higher profit persistence have also higher stock returns and these returns are less volatile than for firms with lower profit persistence.