The Asymmetric Relation Between Changes in Operational Efficiency and Stock Returns

Abstract

According to prior literatures, there exists a positive relation between current stock returns and changes in operational efficiency. It indicates that equity investors reward an increase in a firms operational efficiency and penalize a decrease in the efficiency. However, I find that the positive relation between stock returns and efficiency changes diminishes when sales decrease. This is because in sales-declining periods, equity investors cannot discern whether the reason for a decrease (an increase) in efficiency is inefficient (efficient) management or managers optimistic (pessimistic) expectations about future performance. I also find that the positive relation between stock returns and efficiency changes is weakened in sales-decreasing periods, only when the efficiency changes are driven by managers costs adjustment decisions. Moreover, I find that the positive relation is more weakened in sales-decreasing periods in firms with lower information asymmetry. This study contributes to accounting literatures in that it suggests the direction of sales changes influences not only managers but also equity investors behavior.