Working Paper no. 128
By Andrew Benito
This paper examines company-level persistence in profitability over the period 1975-98. The competitive forces that act to compete away abnormal returns need not act symmetrically and may differ at different points in the distribution of profitability. This suggestion is tested empirically on an unbalanced panel of 2,129 companies. First, evidence for both asymmetries and non-linearities in the persistence of company profitability is found. The results are consistent with the notion that competitive forces act less swiftly to eliminate superior returns than inferior returns and/or that companies attempt to allocate a positive result to more years than they would allocate a poor result. Second, by imposing a linear specification, previous studies are likely to have understated the extent of persistence of superior profitability. Third, industry variation in the extent of profit persistence is considered. Under the standard linear model such variation across industries is quite small. A greater degree of variation between industries is found when allowing for persistence in a non-linear fashion. But the finding that high profitability persists more than low profitability is common across each industry.