{"title":"The endogeneity of profitability and investment","authors":"Peter Chinloy, Matthew Imes","doi":"10.1007/s11156-024-01357-2","DOIUrl":null,"url":null,"abstract":"<p>In academic research, stock returns are frequently regressed on financial variables such as profitability, value, and investment. Managers, who are incentivized through equity compensation, may make decisions which affect financial variables. If such decisions are endogenous, statistical significance in the financial variable coefficient estimates may stem from correlation rather than causation. This study presents a causality framework between U.S. firm decisions and stock returns. A set of instruments is first correlated with stock returns. When fitted values predict returns, there is a confirmed anomaly. Fitted values then replace profitability, investment, and investment growth. Return significance falls by more than half for profitability and investment, while its predicted growth is insignificant. Vector autoregressions and graphic analysis confirm the flow of causality from predicted profitability and investment to stock returns.</p>","PeriodicalId":47688,"journal":{"name":"Review of Quantitative Finance and Accounting","volume":"111 1","pages":""},"PeriodicalIF":1.9000,"publicationDate":"2024-09-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":"0","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Review of Quantitative Finance and Accounting","FirstCategoryId":"1085","ListUrlMain":"https://doi.org/10.1007/s11156-024-01357-2","RegionNum":0,"RegionCategory":null,"ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"Q2","JCRName":"BUSINESS, FINANCE","Score":null,"Total":0}
引用次数: 0
Abstract
In academic research, stock returns are frequently regressed on financial variables such as profitability, value, and investment. Managers, who are incentivized through equity compensation, may make decisions which affect financial variables. If such decisions are endogenous, statistical significance in the financial variable coefficient estimates may stem from correlation rather than causation. This study presents a causality framework between U.S. firm decisions and stock returns. A set of instruments is first correlated with stock returns. When fitted values predict returns, there is a confirmed anomaly. Fitted values then replace profitability, investment, and investment growth. Return significance falls by more than half for profitability and investment, while its predicted growth is insignificant. Vector autoregressions and graphic analysis confirm the flow of causality from predicted profitability and investment to stock returns.
期刊介绍：
Review of Quantitative Finance and Accounting deals with research involving the interaction of finance with accounting, economics, and quantitative methods, focused on finance and accounting. The papers published present useful theoretical and methodological results with the support of interesting empirical applications. Purely theoretical and methodological research with the potential for important applications is also published. Besides the traditional high-quality theoretical and empirical research in finance, the journal also publishes papers dealing with interdisciplinary topics.
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