Unveiling low productivity premium: A tale from emerging market

Abstract

This study investigates how firm-level productivity, measured by total factor productivity (TFP), is priced in cross-sectional stock returns in China, which is the largest emerging market as well as the global manufacturing hub. We document a significant low productivity premium with an annualized return of 6.6 %, where firms with lower productivity earn higher returns compared to their higher counterparts. Low productivity firms are characterized by small size, low value, weak current profitability, illiquidity, high earnings, and idiosyncratic volatility. The low productivity premium phenomenon is robust based on comprehensive sets of empirical models and even after controlling for conventional risk factors and alternative firm characteristics. We further explore potential explanations for the low productivity premium and find that the phenomenon is primary driven by mispricing associated with arbitrage limits. Our results extend the asset pricing literature by highlighting the distinct dynamics of production-based premium in emerging markets, providing novel insights for academics, regulators, and investors interested in understanding the return predictability in immature emerging market.