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SICs as Delineators of Economic Markets
Abstract
The Standard Industrial Classification (SIC) is often used to divide firms into homogeneous markets. Firms classified into the same (n + 1)-digit SIC are thought to be more homogeneous than firms sharing only the same n-digit SIC. This study measures how well the SIC succeeds at combining firms into homogeneous economic markets. Assuming that firms in more similar economic markets should display more similar sales changes, profit rates, or stock price changes than firms in less similar economic markets, the author finds that the SIC is not successful at identifying firms with such similar characteristic variables. Copyright 1989 by the University of Chicago.
... In this paper, I examine the decoupling of actual business activities and stated business areas officially announced through each firm's SIC code. In the SIC system used in most countries, including Korea, a firm is generally assigned an SIC code that indicates the business area accounting for the greatest share among all of that firm's business areas [31]. Therefore, the SIC code of a firm is the official declaration of its identity in terms of its main business area. ...
... Organizational ecology literature suggests that the positioning of an organization in classification categories significantly affects the perception and evaluation of its identity by various audience groups [1,3]. Thus, regardless of accuracy, the classification of business firms based on SIC codes is used in decisions for industrial policy, diversification, investments, loans, regulation, taxation, stock trading, mergers and acquisitions, and so forth, by relevant stakeholders such as consumers, company executives, investors, banks, data service agencies, regulators, IRS, SEC, and the government [31,[34][35][36]. Therefore, a firm has a strategic incentive to declare its SIC code in a way that represents itself more favorably in the eyes of the stakeholders, sometimes at the cost of sacrificing the accuracy of depicting its actual activities. ...
... Therefore, the identity ambiguity analyzed in this study mostly results from the firm's diversification into new business areas outside its officially declared SIC code, or from its partial or full withdrawal from the previously declared business area. Inconsistency between SIC codes and actual activities was examined by Kahle and Walkling [36], Clarke [31], Guenther and Rosman [34], and Fan and Lang [35]. Clarke [31] especially noted that the assignment of an SIC code to diversified multi-business firms is often misleading, considering the historical fact that the SIC system was initially developed to classify individual manufacturing establishments. ...
I examine how firms affiliated with Korean business groups utilize decoupling of the stated business area and actual business activities to maintain the economic sustainability of their organizations. In examining the strategic sources of decoupling, I focus on the idiosyncratic nature of Korean business groups, otherwise known as chaebols. I suggest that decoupling of the stated and actual business areas of a chaebol affiliate is affected positively by the number of regulations in the industry, positively by the relative resource endowment of the affiliate within the chaebol, and negatively by the affiliate’s niche overlap with other affiliates. However, the negative effect of niche overlap was moderated by the affiliate’s relative resource endowment.
... The ubiquity of the SIC coding scheme, and its successor the NAICS, has made it a de facto system of industrial classification for both private (e.g., Compustat, CRSP, PIMS, etc.) and public (U.S. Census of Manufactures) databases. This ubiquity has also generated controversy over the validity of SIC codes (e.g., Bhojraj, Lee, and Oler, 2003;Clarke, 1989;Fertuck, 1975). Clarke (1989) expressed considerable skepticism that the SIC system provides a valid description of competitive markets, suggesting that "empirical industrial organizational research should be carefully evaluated to determine its sensitivity to the use of a possibly spurious classification system" (p. ...
... This ubiquity has also generated controversy over the validity of SIC codes (e.g., Bhojraj, Lee, and Oler, 2003;Clarke, 1989;Fertuck, 1975). Clarke (1989) expressed considerable skepticism that the SIC system provides a valid description of competitive markets, suggesting that "empirical industrial organizational research should be carefully evaluated to determine its sensitivity to the use of a possibly spurious classification system" (p. 29). ...
... At the industry level, we have already reviewed the evidence for inconsistencies in, and differences of opinion about, the fidelity of various formal industrial classification systems such as SIC and NAICS codes (e.g., Bhojraj et al., 2003;Clarke, 1989;Fama and French, 1992;Hoberg and Phillips, 2010). Such differences have been found in other codified systems of market classification as well. ...
Research summary: In this article, we review, integrate, and extend the literature on markets,
competition, and categories as it applies to strategic management theory. Developments in the
literatures of economics and organizational theory have shed new light on market categories
and category dynamics. These developments highlight the fact that boundary questions are
fundamental to the competitive process, and represent a fertile area for research and theory.
The objective is to encourage a theoretically grounded rapprochement between current strategic
management research and both older and newer research on categories and competition.
Managerial summary: One of the key problems for business strategists is understanding the
competitive environment and interpreting the effects of competition on a business. This article
attempts to integrate various literatures in the study of competition by suggesting that strategists
play a crucial role in linking abstract categories of firms and products that have become part of an
industry’s terminology with real-time competitive processes taking place among firms and buyers.
Strategists interpret cues such as cross-elasticities of demand among their own and competing
products and connect these cues to taken-for-granted categories demarcating the boundaries
of markets. Simultaneously, strategists are introducing new categories by reformulating old
nomenclatures and introducing new ones. We also trace the possible effects of this ‘competitive
sensemaking’ on firm behaviors. Copyright © 2016 John Wiley & Sons, Ltd.
... The ubiquity of the SIC coding scheme, and its successor the NAICS, has made it a de facto system of industrial classification for both private (e.g., Compustat, CRSP, PIMS, etc.) and public (U.S. Census of Manufactures) databases. This ubiquity has also generated controversy over the validity of SIC codes (e.g., Bhojraj, Lee, and Oler, 2003;Clarke, 1989;Fertuck, 1975). Clarke (1989) expressed considerable skepticism that the SIC system provides a valid description of competitive markets, suggesting that "empirical industrial organizational research should be carefully evaluated to determine its sensitivity to the use of a possibly spurious classification system" (p. ...
... This ubiquity has also generated controversy over the validity of SIC codes (e.g., Bhojraj, Lee, and Oler, 2003;Clarke, 1989;Fertuck, 1975). Clarke (1989) expressed considerable skepticism that the SIC system provides a valid description of competitive markets, suggesting that "empirical industrial organizational research should be carefully evaluated to determine its sensitivity to the use of a possibly spurious classification system" (p. 29). ...
... At the industry level, we have already reviewed the evidence for inconsistencies in, and differences of opinion about, the fidelity of various formal industrial classification systems such as SIC and NAICS codes (e.g., Bhojraj et al., 2003;Clarke, 1989;Fama and French, 1992;Hoberg and Phillips, 2010). Such differences have been found in other codified systems of market classification as well. ...
In this paper, we review, integrate, and extend the literature on markets, competition, and categories as it applies to strategic management theory. Developments in the literatures of economics and organizational theory have shed new light on market categories and category dynamics. These developments highlight the fact that boundary questions are fundamental to the competitive process, and represent a fertile area for research and theory. The objective is to encourage a theoretically grounded rapprochement between current strategic management research and both older and newer research on categories and competition. One of the key problems for business strategists is understanding the competitive environment and interpreting the effects of competition on a business. This paper attempts to integrate various literatures in the study of competition by suggesting that strategists play a crucial role in linking abstract categories of firms and products that have become part of an industry's terminology with real-time competitive processes taking place among firms and buyers. Strategists interpret cues such as cross-elasticities of demand among their own and competing products and connect these cues to taken-for-granted categories demarcating the boundaries of markets. Simultaneously, strategists are introducing new categories by reformulating old nomenclatures and introducing new ones. We also trace the possible effects of this “competitive sensemaking” on firm behaviors.
... In resolving the first research question and in line with our strategic group definition, we extend Kennedy's (2008) proposition by using the networks formed by co-mentions of firms in the same news articles (so-called co-mention networks) along with the concept of structural equivalence to identify strategic groups. Different from the prior literature (see Ingram and Yue, 2008), we focus on the co-mention network shaped by actual corporate events -outcomes of managers' cognitive process (Kaplan, 2011;Nadkarni and Barr, 2008;1989;Thomas et al, 1993), expressed views of executives and changes in the operating environment as well as journalists' cognitive embeddedness (Kennedy, 2008). The inclusion of journalists' cognitive interrelationships adds a layer of alternative cognition to that of managers extending collective cognitive boundaries. ...
... Categorising firms into comparable groups is of interest to different disciplines. The economists are interested in the gradient of substitutability among products Pakes, 1995, 2004;Einav and Levin, 2010;Nevo, 2001;Petrin, 2002) and the classification of industries (Bhojraj, Lee, and Oler, 2003;Clarke, 1989;Fertuck, 1975). ...
Technological advancement compounds the complexity of competitor identification making it increasingly multi-front and multi-dimensional. Strategic groups are an important unit for competition analysis, typically delineated by firms' characteristic similarities or cognitive maps. Both have inadequacies-the former produces methodological artefacts, and the latter is subject to scale limitations, replicability and managers' cognitive blind spots. Hence, the need for alternatives supplementing the existing approaches. We propose a novel grouping methodology based on news co-mentions, reflecting factual corporate events, executives' and journalists' views, and environmental changes. It yields three advantages. First, news depicts interorganizational relationships, alleviating the concern that strategic groups are statistical artefacts. Second, the approach supplements managers' cognition with that of journalists. Third, the public availability of data offers replicability. The proposed methodology is applied to a sample collected from the US high-tech sector. We document commonalities between the co-mention-based groups and the conventionally-used characteristic-based approach. However, the similarity and groups yielded from news co-mentions go beyond characteristic similarities in explaining competitive inclination, suggesting that the co-mention-based approach offers a robust alternative to identifying competitors and strategic groups. Overall, by developing a novel methodology based on a strong theoretical foundation, this study sheds new light on strategic group research.
... This creates a conflict between four-digit and threeand two-digit classification. Clarke (1989) provides a good example. If a firm has 40% of its revenues in SIC 3211, and 30% in both SICs 2842 and 2845, the firm will be assigned SIC code 3211, which implies a three-digit SIC of 321 and a two-digit SIC of 32. ...
... He finds that three-digit SIC groupings are moderately powerful (explain about 11% of variation in returns) while two-and one-digit SIC grouping are extremely weak (explain about 3% of variations in returns). Clarke (1989) tests the SIC system power in creating groups of firms with similar characteristics. He finds that the SIC system cannot identify homogeneous economic markets and, in contrast to Fertuck (1975), he reports that coarser (one-digit) grouping is more effective than finer (three-and four-digit) grouping. ...
The interrelation between different sources of relatedness in M&A transactions has been largely overlooked in extant literature. This paper offers theoretical and empirical investigation and introduces a few new measures of relatedness. We find that single-dimensional measures of relatedness are complements, not substitutes, of each other, and their impacts on the market’s reaction are additive and interdependent. Specifically, each measure contains unique relatedness information and the market’s perception of, and reaction to, the presence of relatedness in M&A deals is more sophisticated than the extant literature prescribes. The market seems to reward operational and marketing relatedness in small-vicinity mergers and out-of-state mergers. In contrast, related in-state mergers seem to be associated with a significantly negative market reaction. Similarly, technology affiliation induces an additional positive market reaction that is separate from simple industry matching, and the market seems to reward the acquisition of high-technology targets by high-technology acquirers and to penalize the acquisition of high-technology targets by non-high-technology acquirers. Furthermore, we find that horizontally and vertically related mergers are relatively more likely to be completed, while in-state and large-vicinity mergers are less likely to be completed. We also find that when the target is incorporated in a target-friendly state, the merger is less likely to be completed, though state-specific merger laws do not contribute significantly to mergers’ valuation. Taken together, our results indicate that relatedness is a multidimensional metric composed of several interrelated components, and, thus, single-dimensional proxies are not sufficient to capture relatedness accurately and completely.
... We classify product markets (industries) at the four-digit SIC code level. As pointed out by Clarke (1989) , some four-digit SIC codes may fail to define sound economic markets. To minimize such concerns, we follow Clarke (1989) and Karuna (2007) and exclude four-digit SIC codes ending with zero and nine. ...
... As pointed out by Clarke (1989) , some four-digit SIC codes may fail to define sound economic markets. To minimize such concerns, we follow Clarke (1989) and Karuna (2007) and exclude four-digit SIC codes ending with zero and nine. Our final sample consists of 99,214 firm-year observations and 5,275 industry-year observations. ...
This paper examines the relation between the degree and type of strategic interaction among industry firms and firm performance. As a measure of firm performance, we use data envelopment analysis (DEA) to estimate the efficiency of a firm relative to the ‘best practice’ firms in its industry. We find that firms in industries with higher levels of strategic interaction are less efficient and the negative relation is more pronounced in industries where firms compete in strategic substitutes. This finding is consistent with the idea that there is significantly more cooperation (tacit collusion) under strategic complements than strategic substitutes. We also find that frontier efficiency methodology outperforms other measures of firm performance in explaining the relation between strategic interaction and firm performance.
... Despite the wide use of SIC codes, researchers argue that SIC system has serious problems and limitations. Clarke (1989) investigates the intra-industry (industry as identified by SIC) homogeneity and finds that SIC does a poor job of grouping firms with similar sales growth, profit margins and stock return. Clarke (1989) provides a classic example of the possible source of error associated with SIC. ...
... Clarke (1989) investigates the intra-industry (industry as identified by SIC) homogeneity and finds that SIC does a poor job of grouping firms with similar sales growth, profit margins and stock return. Clarke (1989) provides a classic example of the possible source of error associated with SIC. Consider a firm with three products: 40% revenue in SIC 3211, and 30% each in SIC 2842 and 2845. ...
... Similarly, these classification systems may be too broad or miss the mark when identifying companies which are similar (Clarke, 1989). In contrast, analyst-based approaches are more likely to yield groupings of similar companies; investment banks 26 staff their analyst coverage in a manner that minimizes information acquisition costs to analysts by assigning analysts to cover sets of similar firms (Ramnath, 2002). ...
... SIC and NAICS, on the other hand, treat vertically related companies as belonging to separate industries and deems them to be unrelated. Furthermore, scholars have also identified substantial issues with classifying multi-business firms into a single SIC code (e.g., Clarke, 1989 in 1987 and its replacement, the NAICS, created in 1997 is only updated every 10 years. ...
The main goal of this dissertation is to better understand how external corporate stakeholder perceptions of relatedness affect important outcomes for companies. In pursuit of this goal, I apply the lens of category studies. Categories not only help audiences to distinguish between members of different categories, they also convey patterns of relatedness. In turn, this may have implications for understanding how audiences search, what they attend to, and how the members are ultimately valued. In the first chapter, I apply incites from social psychology to show how the nationality of audience members affects the way that they cognitively group objects into similar categories. I find that the geographic location of stock market analysts affect the degree to which they will revise their earnings estimates for a given company in the wake of an earnings miss by another firm in the same industry. Foreign analysts revise their earnings estimates downward more so than do local analysts, suggesting that foreign analysts ascribe the earnings miss more broadly and tend to lump companies located in the same country into larger groups than do local analysts. In the second chapter, I demonstrate that the structure of inter-category relationships can have consequential effects for the members of a focal category. Leveraging an experimental-like design, I study the outcomes of nanotechnology patents and the pattern of forward citations across multiple patent jurisdictions. I find that members of technology categories with many close category 'neighbors' are more broadly cited than members of categories with few category 'neighbors.’ My findings highlight how category embeddedness and category system structure affect the outcomes of category members as well as the role that classification plays in the valuation of innovation. In the third chapter, I propose a novel and dynamic measure of corporate similarity that is constructed from the two-mode analyst and company coverage network. The approach creates a fine-grained continuous measure of company similarity that can be used as an alternative or supplement to existing static industry classification systems. I demonstrate the value of this new measure in the context of predicting financial market responses to merger and acquisition deals.
... Since the measurement of managerial risk-taking is at the core of our article, we check that our results are robust to alternative versions of this proxy. The first variation mitigates a concern that SIC codes may be more effective in classifying firms into coarse industrial groups rather than into finer 4-digit segments (Clarke (1989)). To this end, we recompute risk proxies using segments and pure-play portfolios defined at the 2-digit SIC level. ...
This article uses FAS 123R regulation to examine how reduction in CEO compensation incentives affects managerial “playing it safe” behavior. Using proxies reflecting deliberate managerial efforts to change firm risk, difference-in-difference tests show that affected firms drastically reduce both systematic and idiosyncratic risks, leading to an 8% decline in total firm risk. These reductions in risk are achieved by shifting to safer, but low-Q, segments while closing the riskier ones, without significant changes in investment levels. Our findings suggest that decrease in risk-taking incentives provided by option compensation, when not compensated for by alternative incentives or governance mechanisms, exacerbates risk-related agency problem.
... As such, we classified firms as belonging to the same CEO labor market if they share the same two-digit SIC code. Prior research found that two-digit SIC grouping better captures similarities and dissimilarities among firms than three-or four-digit SIC groupings (Clarke, 1989). For this reason, the two-digit SIC industry definition has been commonly used in prior studies that examine the effects of industry categorization on CEO compensation (e.g., Gibbons & Murphy, 1990;Porac, Wade, & Pollock, 1999) and CEO succession (e.g., Parrino, 1997). ...
Previous corporate governance research has paid little attention to the role of chief executive officer (CEO) labor markets in controlling CEO behaviors because the CEO labor market has been considered inefficient. With the increasing mobility of top executives across firms, however, the potential of CEO labor markets to serve as an external disciplining force has been growing. In this study, we argue that CEOs will be more pressured to engage in desirable behaviors as the CEO labor market becomes more efficient. Using a longitudinal sample of S&P 1500 firms in high-technology industries in United States from 2011 to 2019, we found that CEOs tend to increase R&D investment as CEO labor market supply increases. We also found that the tendency is greater when external CEO succession is more frequent in the market. Our results demonstrate that CEO labor markets have the potential to function as an effective external governance mechanism.
... Since prior research reveals that the sectoral classification system employed impacts multiple's accuracy due to varying firms being assigned to industries [e. g. [25][26][27][28][29][30][31], and documents limitations as well as deficiencies of the widely used SIC codes to select and segment samples [25,32,33] due to its treatment of conglomerates [34], its emphasis on manufacturing operations [35] and, its product-based view not capturing vertical relationships among firms [36,37], I employ the NACE Rev.2 industry classification. ...
... In contrast, competitive dynamics research relates the intensity of competition to the market overlap between competitors, acknowledging that fierce rivalry emerges when firms are perceived as close competitors (Porac and Thomas, 1990;Chen, 1996). However, conventional industry categorization encompasses a broad range of firms without distinguishing competitors from non-competing peers (Clarke, 1989;Porac and Thomas, 1990). We expect an event that endangers the competitive position of an industry peer to create a positive spillover to firms that are most proximate to this peer's market domain. ...
Research on misconduct suggests that accusations against industry peers generate negative consequences for non-accused firms (a “stigma effect”). Yet, building on research on competitive dynamics, we infer that such accusations can benefit non-accused firms that compete with these peers (a “competition effect”). To reconcile these opposing perspectives, we posit that the negative stigma effect will increase with greater product market overlap between the non-accused firm and its accused peer, up to a point, beyond which the positive competition effect will counterbalance it. We further conjecture that the competition effect will be relatively more pronounced when the market classification used by investors for assessing the market overlap is more fine-grained. Accordingly, we suggest that more sophisticated investors, who rely on more fine-grained market classifications, increase their shareholdings in non-accused firms to a greater extent than less sophisticated investors as the market overlap between the non-accused firm and the accused peer increases. Using elaborate data on products and investments, we analyze investors’ shareholdings and stock market returns of non-accused firms in the U.S. software industry following accusations of financial misconduct by their industry peers, and we find support for our predictions. Our study elucidates the interplay between stigma and competition following misconduct by industry peers.
... In addition, considering that the China Securities Regulatory Commission made corresponding amendments to the industry distribution standards of Chinese listed companies in 2012, under the new industry distribution standards, how the industry differentiation characteristics of the listed companies' real earnings management are also concerned. Clarke (1989), Guenther, Rosman (1994), Kahle and Walkling (1996) pointed out that scientific industry classification standards are the prerequisite for testing the different characteristics of listed companies in different industries, because different industry classification standards will affect the research variables. The significance level will lead to differences in empirical results, and resulting in differences in research results as well. ...
This article examines the industry differences in the real earnings management behavior of listed companies in China. The study finds that listed companies in the health and social work industries have the highest degree of real earnings management, and the electricity, heat, gas and water production and supply industries has the lowest level of real earnings management, and there are obvious industry differences in real earnings management among Chinese listed companies. The empirical evidence in this paper shows that there are industry differences in the real earnings management of Chinese listed companies.
... To compute industry annual return, we used all of the Romanian companies listed on the BSE and on the over-the-counter market (former RASDAQ) that had the same first two industry code digits. It has been proven that this classification offers a higher homogeneity of returns than statistical clustering or three-or four-digit classification (Chan et al. 2007, Clarke 1989). To minimize the possibility of biases in our results due to outliers, the performance variables, the price/book value, and the leverage ratios were winsorized at 1% and 99%. ...
This work expands the literature on a less studied topic, the Chief Executive Officer (CEO) turnover in post-communist economies, analyzed during an unstable and ambiguous economic and financial environment. For the period 2005–2010, the results indicate the political inference in CEO turnover decision for the Romanian listed companies. In this period, with great turmoil in the economy determined by the financial crisis of 2008, we also find that CEO gender helps to explain the probability of changing the CEO. Moreover, this paper empirically tests if the financial and corporate governance determinants that are validated in the existing literature work for the Romanian listed companies. We reinforce that CEO turnover decision is negatively related to accounting-based performance. We find evidence of the “voting with their feet” behavior of institutional investors, and of the lack of Board of Directors monitoring. The CEO–Chairman duality and the controlling power of the largest shareholder act as entrenchment mechanisms.
... 3 Although most of capital market studies use Standard Industry Classification (SIC) system, studies that report some problems and limitations of SIC codes include Clarke (1989), Kahle and Walking (1996), Guenther and Rosman (1994), and Fan and Lang (2000). Therefore, other classification methods have been adapted recently such as North American Industry Classification System (NAICS), Global Industry Classifications Standard (GICS) system Bhjoraj, Lee, and Oler (2003). ...
Using a UK panel data set drawn from 1675 Chief Executive Officer (CEO) year observations and 1540 Chief Financial Officer (CFO) year observations, we examine the relationship between CEO and CFO equity incentives and earnings management. In addition, we examine the moderation effect of corporate governance mechanisms on the relationship between executives’ equity incentives and earnings management. We use multivariate regression models to test our hypotheses. We find that CEO equity incentives are related to higher absolute and income increasing earnings management. These results support the managerial power theory argument that CEOs exploit equity-linked compensation to obtain more personal benefits without causing public anger. Contrary to CEO equity incentives, we could not find any significant relationship between CFO equity incentives and any of the earnings management proxies. In addition, we find that corporate governance quality (measured by individual mechanisms and overall index) has no effect on the relationship between executives’ equity incentives and earnings management. This result indicates that whereas some corporate governance mechanisms can reduce earnings management in general, they do not affect wealth driven incentives to manipulate accruals. In total, results question the effectiveness of the corporate governance system in mitigating opportunistic behavior motivated by executives’ compensation structures
... In [2], Ban et al. use a kNN-based regression method to predict future values of stock prices. The fundamental assumption is based on economic intuition from [5] that within-industry returns correlate highly compared to cross-industry returns. A two-tier, multivariate regression method for financial time series forecasting is used to exploit this fact. ...
Stream classification algorithms traditionally treat arriving instances as independent. However, in many applications, the arriving examples may depend on the “entity” that generated them, e.g. in product reviews or in the interactions of users with an application server. In this study, we investigate the potential of this dependency by partitioning the original stream of instances/“observations” into entity-centric substreams and by incorporating entity-specific information into the learning model. We propose a k-nearest-neighbour-inspired stream classification approach, in which the label of an arriving observation is predicted by exploiting knowledge on the observations belonging to this entity and to entities similar to it. For the computation of entity similarity, we consider knowledge about the observations and knowledge about the entity, potentially from a domain/feature space different from that in which predictions are made. To distinguish between cases where this knowledge transfer is beneficial for stream classification and cases where the knowledge on the entities does not contribute to classifying the observations, we also propose a heuristic approach based on random sampling of substreams using k Random Entities (kRE). Our learning scenario is not fully supervised: after acquiring labels for the initial m observations of each entity, we assume that no additional labels arrive and attempt to predict the labels of near-future and far-future observations from that initial seed. We report on our findings from three datasets.
... In [6], Ban, et al. use a kNN based regression method to predict future values of stock prices. The fundamental assumption is based on economic intuition from [7] that within-industry returns correlate highly compared to cross-industry returns. A two-tier, multivariate regression method for financial time series forecasting is used to exploit this fact. ...
... The industry clusters from Amadeus are required to include a minimum of five observations per year and industry (two-digit ISIC), otherwise the adjustment reports missing data. We use two-digit industry controls because Clarke (1989) shows that the difference between two-digit and four-digit SIC controls is marginal. Following Barber and Lyon (1996) and Pérez-González (2006), we design performance adjustments by sorting the industry-adjusted variable of the Amadeus database into deciles for each year. ...
Empirical studies examining firm performance following CEO succession in family firms predominantly document inferior performance of family successors. This evidence is at odds with general theoretical literature that attests a positive effect of family involvement inside the firm. To explore this enigma, we theoretically and empirically disentangle the influence of the CEO attribute “family member” (i.e. the CEO is affiliated to the family), on post-succession firm performance, from other, distinct CEO attributes (e.g., CEO-related human capital). Our analysis on the individual CEO level shows that after respective controls the “family member attribute” is significantly positively related to post-succession firm performance.
Full version is available here (Sage):
https://journals.sagepub.com/doi/10.1177/1042258718816290
... The purpose of industry classification is to divide firms into homogeneous markets with the assumption that firms in similar market should exhibit similar firm characteristics, such as profitability and sales change (Clarke, 1989). However, the existing industry classification schemes, including the SIC and the NAICS, have two major limitations. ...
This study proposes a quantitative method using the eXtensible Business Reporting Language financial accounting taxonomies to identify firms' common business characteristics and demonstrates that this graph mining approach can effectively identify industry boundaries. The premise of this method is based on the previous findings that financial accounts and the structural semantic information represented in financial statements reveal firms' general business operations and common characteristics if they have similar business models. Specifically, we introduce a graph similarity metric combined with spectral clustering algorithm to quantify the similarity of financial disclosures. Through industry classification comparison with the traditional classification schemes, the Standard Industrial Classification and the North American Industry Classification System, we show that the proposed method consistently clusters firms into their respective industries based on financial disclosures with significantly lower variance in a time‐varying fashion. This novel graph mining method provides an automated way for decision makers to identify common business operations as well as detecting potential financial fraud and uncovering accounting information misrepresentation.
... The industry clusters from Amadeus are required to include a minimum of five observations per year and industry (two-digit ISIC), otherwise the adjustment reports missing data. We use two-digit industry controls because Clarke (1989) shows that the difference between two-digit and four-digit SIC controls is marginal. Following Barber and Lyon (1996) and Pérez-González (2006), we design performance adjustments by sorting the industry-adjusted variable of the Amadeus database into deciles for each year. ...
... To control for industry effects, the raw operating performance measures are adjusted by subtracting the median value of the corresponding measures for all firms in the primary two-digit SIC industry in every event year, and then perform the above test procedures. A two-digit industry definition is used because Clarke [10] has shown that the two-digit definition captures similarities among firms as effectively as industry definitions based on three-or four-digit SIC groupings. ...
... When deciding for firms belongs to a business sector classification, for example in the U.S, they use a Standard Industrial Classification (SIC) Code based of production process or selling end product. But the issue is when the business growth with various products and services that resulted into question the usefulness of the SIC system (Clarke, 1989). Then, they are being replaced by North American Industry Classification System (NAICS) codes. ...
... The industry clusters from Amadeus were required to include a minimum of five observations per year and industry (two-digit ISIC), otherwise the adjustment reports missing data. We used two-digit industry controls because Clarke (1989) shows that the difference between two-digit and four-digit SIC controls is marginal. Following Barber and Lyon (1996) and Pérez-González (2006), we designed performance adjustments by sorting the industry-adjusted variable of the Amadeus database into deciles for each year. ...
Early research on succession in owner-led family firms described succession as a process of mutual role adjustment. This means the parallel lessening of the previous owner's involvement (POI) while a new generation family member gradually takes office as new CEO and owner. In this article, we analyze the performance impact of the frequent phenomenon of POI in the post-succession phase in owner-led family firms. Drawing on upper echelon theory and agency theory, we argue that POI is a two-sided strategy. We posit and test a comprehensive framework that integrates both positive and negative aspects of POI. Moreover, we show that whether POI radiates more salubrious than noxious effects to the family firm is highly context specific. Using 2SLS-IV regressions with multiple instruments to address a potential endogeneity of POI, we find that POI is positively related to performance when the successor's CEO-related human capital (i.e. CEO-related experience and education) is still limited, but turns negative with increased CEO-related human capital of the successor. Furthermore, we show that the performance effect of POI is linked to corporate age: it is positively associated with performance in younger firms, while this positive relation vanishes with increasing corporate age. We observe that both effects are amplified by the previous owner's discretion (i.e. the latitude of actions to shape organizational results) post-succession.
... Second, the resultant data is not necessarily provided (by government agencies) as a simple one-click/single-file download. 5 For economics, financial economics and accounting related literature, see, e.g., [Clarke, 1989], [Cotterman & Peracchi, 1992], [DellaVigna & Pollet, 2007], [Evangelista, 2000], [Guibert et al, 1971], [Heston & Rouwenhorst, 1994], [Hicks, 2011], [Hill, 1999], [Hrazdil & Scott, 2013], , [Hrazdil & Zhang, 2012], [Kile & Phillips, 2009], [Kort, 2001], [Krishnan & Press, 2002], [Laestadius, 2005], [Ojala, 2005], [Pavitt, 1984], [Peneder, 2003], [Perry et al, 1985], [Pol et al, 2002], [Schröder & Yim, 2012], [Scislaw, 2015]. For a recent review, see, e.g., [Phillips & Ormsby, 2016]. ...
We provide complete source code for building a fundamental industry classification based on publically available and freely downloadable data. We compare various fundamental industry classifications by running a horserace of short-horizon trading signals (alphas) utilizing open source heterotic risk models (https://ssrn.com/abstract=2600798) built using such industry classifications. Our source code includes various stand-alone and portable modules, e.g., for downloading/parsing web data, etc.
... Using data compiled with SIC codes therefore has limited potential for identifying the greening of economic activity, as 'the production of environmental goods and services cuts across the whole economy and will often only represent a fraction of an organization's output, being a secondary or ancillary activity' (Livesey 2010, 52). Many studies have questioned the utility of SIC codes for research across a number of fields (Clarke 1989highlighted the difficulties for emergent twenty-first century industries and technologies and the limitations of SIC codes are greater when attempting to partition high-tech firms. SIC codes were established in the 1930s when the focus of the US economy was manufacturing. ...
Over the past decade, the green economy has emerged as an important policy framework for sustainable development in both developed and developing countries. It presents an attractive framework to deliver more resource efficient, lower carbon, less environmentally damaging, more socially inclusive societies. There are tensions between competing green economy discourses and a number of different definitions exist, all of which have major shortcomings. This is further complicated by the different underlying concepts of the ‘weak’, ‘transformational’ and ‘strong’ green economy. Several important definitions focus on the aspirational ‘transformational green economy’. To enable and to track this ‘transformation’, economic and environmental measurement is essential. Current approaches are still in development, lack available data or show inconsistencies with proposed definitions, and thus may neither support effective decision-making nor efforts to transform economies. This review identifies these current shortcomings and makes four overarching recommendations for improving measurement for green economy transformations, including cheaper, faster and more widely available data, and broader frameworks for measuring economy–society–environment interactions. We suggest that proper measurement of the green economy needs to move beyond GDP as the central measure of progress and to better track the ‘transformational green economy’. This will enable the green economy to become relevant again at national and international levels, given the emerging Sustainable Development Goals and post-COP 21 frameworks.
... In fundamental stock correlation analysis, the focus is on the investigation of stocks' fundamental attributes [7], regardless of any numerical financial calculation. In [8], Clarke stated that economic intuition supports the idea that firms in the same industry share high return correlations compared to firms in different industries. ...
In this paper we propose a new multivariate regression approach for financial time series forecasting based on knowledge shared from referential nearest neighbors. Our approach defines a two-tier architecture. In the top tier, the nearest neighbors that bear referential information for a target time series are identified by exploiting the financial correlation from the historical data. Next, the future status of the target financial time series is inferred from heritage of the time series by using a multivariate k-Nearest-Neighbour (kNN) regression model exploiting the aggregated knowledge from all relevant referential nearest neighbors. The performance of the proposed multivariate kNN approach is assessed by empirical evaluation on the 9-year S&P 500 stock data. The experimental results show that the proposed approach provides enhanced forecasting accuracy than the referred univariate kNN regression.
The number and trade volume of Chinese firms are increasing year by year. The resulting variety of complex transactions have made risk control and government supervision difficult. China’s listed companies have specific classifications, but most non-listed companies do not have comparable classifications, making it difficult to analyze all companies on the same basis. Supply chain networks have proved to contain rich information, which can more completely reflect transaction relationships. This study mines hidden information obtained from the supply chain network to classify participating companies. We construct the supply chain network data set of listed companies, and use the graph neural network (GNN) algorithm to classify these companies. Experiments show that this method is effective and can produce better results than the commonly used machine learning methods. On average the accuracy of industry classification for listed companies is improved by over 2%, and time required is greatly reduced. In addition, we use economic variables derived from supply chain concepts to try to explain the effectiveness and economic significance of GNN, and find that GNN can also be used to classify companies into multiple industries. Our findings provide new insights, as well as a potential method to label a private company’s industry using only public text information, which can be used for the study of smart industry classification and mining implicit information from the perspective of supply chain networks.
Manuscript Type: Empirical Research Question/Issue: This study uses the 1989 Canada‐U.S. Free Trade Agreement (FTA) to study the effect of increased foreign competition on the efficiency of major corporate investment decisions. The analysis builds on the disciplining theories of competition that suggest that managers facing greater competition should make better investment decisions, resulting in more wealth created for shareholders. Research Findings/Insights: Using a sample of more than 2,000 mergers and acquisitions, the study finds that acquirers exposed to greater increases in foreign competition experience better acquisition performance. The positive impact of increased competition is stronger in acquirers with relatively higher agency costs prior to the FTA. Managers of acquirers exposed to greater foreign competition are more likely to be terminated following value‐destroying acquisitions. Theoretical/Academic Implications: This study provides novel empirical evidence showing that increased foreign competition results in better investment decisions and that the result is likely due to the disciplining effects of competition. This evidence adds to a growing body of work on the disciplining role of competition and on the effects of increased foreign competition on corporate decision‐making. Practitioner/Policy Implications: This study is relevant to policymakers because the extent of competition can be influenced by policy decisions. For regulators, it is worth considering that reducing import tariffs and other entry barriers into product markets may lower agency costs and increase the efficiency of corporate investment. This is a topical issue due to the increase in globalization and ongoing debates about further liberalization of trade relations.
The main aim and contribution of this study is to outline and demonstrate the usefulness of a machine learning approach to address prediction-based research problems in accounting research, and to contrast this approach with a more conventional explanation-based approach familiar to most accounting scholars. To illustrate the approach, the study applies machine learning to predict a firm’s industry sector using the firm’s publicly available financial statement data. The results show that an algorithm can predict an industry sector with just this data to a high degree of accuracy, especially if a non-linear classifier is used instead of a linear classifier. Additionally, the algorithms were able to carry out an industry-firm pairing exercise taken from introductory accounting text books and MBA cases, with predicted answers showing a high degree of accuracy in carrying out this exercise. The study shows how machine learning approaches and algorithms can be valuable to a range of accounting domains where prediction rather than explanation of the dependent variable is the main area of concern.
CEOs of S&P 500 firms that report high non-GAAP earnings relative to GAAP earnings receive substantial unexplained pay. Crucially, this result remains even after controlling for the level of non-GAAP and GAAP earnings. These firms are relatively poor performers (i.e., low GAAP earnings and stock returns) and have less powerful CEOs, consistent with non-GAAP earnings being used as justification when high executive pay is more likely to cause outrage. Additionally, despite the lower GAAP and return performance, these firms are more likely to beat the earnings targets specified in their compensation plans, which likely increases investors' perceptions of core operating earnings and reduces outrage. Indeed, these firms face less dissent from shareholders and proxy advisors, and no additional media scrutiny. Our evidence suggests that the fraction of CEO pay that seems attributable to opportunistic non-GAAP reporting, while limited, is economically meaningful.
JEL Classifications: G14; G34; G38; M12; M41.
Institutional cross-owners, specifically institutional investors with significant stakes in multiple firms in the same industry, are becoming increasingly common in the United States. In this paper, we investigate and find that the presence of institutional cross-owners facilitates a firm's financing of its investment opportunities, consistent with institutional cross-owners reducing the adverse selection concerns of those who provide capital for the investment opportunities. We then examine the conditions under which the presence of institutional cross-owners is likely to more significantly reduce adverse selection and thereby have even more of a positive effect on the financing of investment opportunities. We document that relative to transient institutional cross-owners, dedicated institutional cross-owners facilitate more financing of investment opportunities. We also find that institutional cross-owners facilitate the financing of investment opportunities even more for firms with greater dependence on external financing, those with an opaque financial reporting environment, and those with more product market competition. Our paper offers novel insight into how a firm can benefit from the presence of institutional cross-owners.
This paper uses FAS 123R regulation to examine how reduction in CEO compensation incentives affects managerial 'playing-it-safe' behavior. Using proxies reflecting deliberate managerial efforts to change firm risk, difference-in-difference tests show that affected firms drastically reduce both systematic and idiosyncratic risks, leading to an 8% decline in total firm risk. These reductions in risk are achieved by shifting to safer, but low-Q, segments while closing the riskier ones, without significant changes in investment levels. Our findings suggest that decrease in risk-taking incentives provided by option compensation, when not compensated for by alternative incentives or governance mechanisms, exacerbates risk-related agency problem.
We investigate the role of Relative Performance Evaluation (RPE) theory in CEO pay and turnover using a product similarity-based definition of peers (Hoberg and Phillips 2016). RPE predicts that firms filter out common shocks (i.e., those affecting the firm and its peers) while evaluating CEO performance, and that the extent of filtering increases with the number of peers. Despite the intuitive appeal of the theory, previous tests of RPE find weak and inconsistent evidence, which we argue is due to the imprecise categorization of peers. Using product market peers, we find three pieces of evidence consistent with RPE in relation to CEO pay and forced turnover: (1) on average, firms partially filter out common shocks to stock returns, (2) the extent of filtering increases with the number of peers, and (3) firms completely filter out common shocks in the presence of a large number of peers.
JEL Classifications: M40; M41; G30; J33.
SYNOPSIS
Researchers and practitioners have used industry classification systems (e.g., SIC) to select peer firms and create an evaluation benchmark. However, we argue that the choice of peer firms should depend on the research goals. A single peer selection method is not adequate in all circumstances. This study provides a novel approach that yields flexible groupings of firms using clustering techniques. We select the set of financial ratios related to a particular research objective and apply K-medians clustering to identify peer firms. In the subsequent year, a new variable is constructed to capture firms' deviation from peer firms. Significant deviations between a firm and its peers may indicate potential anomalies. We evaluate the usefulness of this K-medians clustering-based peer selection approach by incorporating this variable into a misstatement detection model and a bankruptcy prediction model and find that information about the clustering-based peers can enhance the performance of existing models.
We find a U-shaped relation between industry concentration and innovation. The relation is driven by neck-and-neck industries where firms operate with similar productivity. When industry concentration is low, innovation intensity decreases as concentration increases. However, when industry concentration is high, increased concentration causes industry firms to increase innovation intensity to escape competition. The U-shaped relation is more pronounced in industries where firms compete in strategic substitutes. Using tariff rate reductions as an exogenous shock to the competitive environment, firms in neck-and-neck industries and industries where firms compete in strategic substitutes respond to foreign competitive threats by increasing innovation intensity.
Using tariff reductions as exogenous shocks to competition and a triple-difference specification on matched samples, we find that when competition increases, firms with overconfident CEOs slash their operating and gross profit margins, and increase advertising and research and development more intensively than rational CEOs do. Their actions lead to increased market share and value for their firms relative to firms led by rational CEOs. Our results imply that CEO overconfidence is beneficial when firms face increased competition.
This paper studies the impact of sales growth above a sustainable level on the financing choices of the firm. Myers [1984] indicates that firms typically employ a pecking order of financing choices, using internal equity before the issuance of external debt, followed by the issuance of external equity. Contingency table analysis performed in this paper provides indirect evidence that the faster firms are growing, the more they use up available internal financing and, thus, must raise funds externally. In addition, logit analysis shows that firms with lower asymmetric information tend to raise the majority of their funds externally, with debt being the primary choice. Together, both sets of results provide indirect support for Myers' pecking order theory since it appears that firms use available internal financing, then debt, then new equity to finance growth.
We analyze the effects of institutional cross-ownership of same-industry firms on product market performance and behavior. Our results show that cross-held firms experience significantly higher market share growth than do non-cross-held firms. We establish causality by relying on a difference-in-differences approach based on the quasi-natural experiment of financial institution mergers. We also find evidence suggesting that institutional cross-ownership facilitates explicit forms of product market collaboration (such as within-industry joint ventures, strategic alliances, or within-industry acquisitions) and improves innovation productivity and operating profitability. Overall, our evidence indicates that cross-ownership by institutional blockholders offers strategic benefits by fostering product market coordination.
Received November 12, 2015; editorial decision December 31, 2016 by Editor Itay Goldstein.
The present study adds to the CMO literature the perspective of firms’ imitative behavior on why firms have CMOs in their TMT. We propose that a firm’s decision to have a CMO on its TMT is driven not only by contingency-reated considerations but also by social ones, as the decision is significantly influenced by industry peers. Empirical findings based on 505 large US firms from 2000 to 2012 indicate that firms’ imitative behavior is a significant driver of CMO presence, especially when firm uncertainty is strong and inference uncertainty is low. Post hoc analyses indicate that this imitation behavior tends to be performance neutral at best.
Relative Performance Evaluation (RPE) theory predicts that firms filter out common shocks (i.e., those affecting the firm and its peers) while evaluating CEO performance, and that the extent of filtering increases with the number of firms in the peer group. Despite the intuitive appeal of the theory, previous tests of RPE find weak and inconsistent evidence. We hypothesize that one reason for the mixed evidence is the inaccurate classification of peers. Rather than using static, pre-defined Standard Industry Classifications (SIC), we exploit recent advances in textual analysis and define peers based on firms’ product descriptions in their 10-K filings (e.g., Hoberg and Phillips (2015)). This alternative classification not only captures common shocks to firms’ product markets more effectively, but also tracks the evolving nature of these product markets, as 10-Ks are updated annually. Using product market peers, we find three pieces of evidence consistent with RPE – (i) firms on average filter out common shocks to performance measures, (ii) the extent of filtering increases with the number of peers, and (iii) firms completely filter out common shocks in the presence of a large number of peers. We are able to replicate the first finding but not the others using SIC codes. Overall, our results suggest that a key identification strategy to testing RPE theory lies in accurately defining the peer group.
From 1970 to 2006, the average cash-to-assets ratio for young manufacturing firms has increased by 1.01% per year, while for mature firms the increase is a mere 0.07%. We investigate this difference in cash holdings and find that cash has a negative impact on the future market share growth of the mature firms, evidence that can better explain the unwillingness of such firms to hold precautionary cash as they face increasingly more volatile cash flows in an imperfect capital market. Further, we show that the relational strength between cash and product market performance evolves in a way that reflects a changing composition of manufacturing firms which progressively tilts toward young firms.
This article uses Tobin's q, the ratio of the market value of a firm to the replacement value of its physical assets, to measure monopoly power and to examine the relationship between market structure and profitability. Tobin's q is a better measure of monopoly profits than indices of single-period profitability because it measures long-run monopoly power. In addition, it is subject to less measurement error and it contains an adjustment for risk. The relationship between q and long-run monopoly power is established. Provided that all inputs are supplied competitively, q should be highly sensitive to even small amounts of monopoly power. Since the level of q is generally not high in the American economy, the result suggests either that monopoly power is absent or that unions manage to capture monopoly rents. Empirical tests of the relationship between Tobin's q and measures of market structure and unionization provide evidence that unions do capture most monopoly rents.
This article employs weekly time series data on the Joint Executive Committee railroad cartel from 1880 to 1886 to test empirically the proposition that observed prices reflected switches from collusive to noncooperative behavior. An equilibrium model of dynamic oligopoly with asymmetric firms, together with explicit functional form assumptions about costs and demand, determines the estimating equations and stochastic structure of the econometric model. The hypothesis that no switch took place, so that price and quantity movements were solely attributable to exogenous shifts in the demand and cost functions, is then tested against this alternative and rejected.