Tài liệu Discussion of Firm Efficiency Level and Equity Returns ppt

Discussion of Firm Efficiency Level and Equity Returns The term "efficient" firm is widely used in economics. For example, an efficient firm is the one producing at Marginal Cost = Marginal Revenue. However, in finance, an "efficient" firm has no specific meaning. We hear efficient market but not efficient firm. Primarily because of two reasons. First, efficiency or MC=MR is difficult to estimate in finance. Second, so what if the firm is efficient? Why should an investor care? Economic theory never told us anything about what will happen next. Maybe a firm is efficient right now will not be in the future. Or if the firm is efficient does that mean its next year stock return will be higher? So why care? A forthcoming article by Nguyen and Swanson (2007) in the Journal of Financial and Quantitative Analysis addresses both of the concerns. Here's its summary snapshot. The paper is divided into two main parts. In the first part, Nguyen and Swanson propose the application of Stochastic Frontier Analysis (SFA), a parametric approach used in productivity economics, to estimate firm efficiency level. While SFA is widely used in economics (also in some economic literature dealing with Vietnam), there have been only 2 SFA papers in top tier finance journals. Essentially what SFA does is estimating a hypothetical value a firm could have obtained if it were to maximize firm value. The deviation from the maximum value is defined as "inefficiency level". Hence, firms with low "inefficiency" are classified as the "efficient" firms. Once firm efficiency levels are determined, Nguyen and Swanson proceed to examine firm performance using asset pricing techniques. Specifically, the authors create deciles (or portfolios) of firms based on the efficiency level. They further create a hedge portfolio which takes a long position in the most inefficient firms and a short position in the most efficient firms. Nguyen and Swanson track the performance of hedge portfolio after adjusting for Fama-French and Carhart (1997) 4-factor model along with Daniel and Titman (1997) characteristics-based benchmark. The paper provides the following main conclusions: 1. A trading strategy of longing inefficient firms and shorting efficient firms yields, on average, a 0.76% monthly risk-adjusted profit. That is almost 12% annual profit. 2. A 5-year buy-and-hold strategy of the hedge portfolio generates, on average, a 44% cummulative return over the course of 5 years. 3. Nguyen and Swanson argue that the difference in performance is generated by a premium associated with investing in highly inefficient firms (much like Fama and French's value premium argument). 4. Interestingly, the authors document that over time the efficiency level of the most inefficient firms tend to increase. This coincides with Fama and French (1995) argument that the worst firms are forced to improve in order to survive in the market. 5. Nguyen and Swanson further document that firm efficiency level appears to subsume the information that is present in Book-to-market ratio (Fama and French's main ratio). The paper provides the following implications and opportunity for further expansion: With respect to Asset Pricing Models: 1. Since current asset pricing models (CAPM, 4-factor and 5-factor by Pastor and Stambaugh) fail to explain the inefficiency premium, should inefficiency premium be included as a pricing factor? 2. Is inefficiency a risk-factor? In other words, is it an aggregate annomaly? Or is it simply a firm specific characteristics phenomenon (as in Daniel and Titman argument)? With respect to Corporate Finance: Nguyen and Swanson document improvement in efficiency among the most inefficient firms. What caused the improvements? Actions by the board of directors (e.g. firing the manager)? Increase in compensation? Cost reduction? Or something else? With respect to International Finance and Vietnam: Does inefficiency premium exist in other markets? With respect to Portfolio Management and Security Analysis: Since inefficiency appear to subsume the information that is present in Book-to-market, then should portfolio managers consider incorporating inefficiency into Style Investments? For example, instead of high B/M being value firms we might have high inefficiency? Note that B/M is a much better proxy for value/growth effect than P/E ratio (Fama and French). . Discussion of Firm Efficiency Level and Equity Returns The term "efficient" firm is widely used in economics. For example, an efficient firm. Hence, firms with low "inefficiency" are classified as the "efficient" firms. Once firm efficiency levels are determined, Nguyen and