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Purpose – The purpose of this paper is to investigate the relationship between the strategic positioning of firms and the sustainability of firm performance. The paper argues that pursuing a differentiation strategy leads to more sustainable financial performance compared to following a cost leadership strategy. However, a differentiation strategy may also be associated with greater risk. Design/methodology/approach – To investigate the research questions, the authors utilize publicly available archival data consisting of 12,849 firm-year observations for the period 1989-2003. In the first stage of the analysis, factor analysis is used to determine firms’ strategic positioning. The resulting factor scores are subsequently used in regression analysis to investigate the sustainability of performance based on the strategic positioning of firms. Findings – The results indicate that both cost leadership and differentiation strategies have a positive impact on contemporaneous performance. However, the differentiation strategy allows a firm to sustain its current performance in the future to a greater extent than a cost leadership strategy. The differentiation strategy, though, is also associated with greater systematic risk and more unstable performance. Originality/value – Sustainability of performance refers to how much a firm's current profitability can be sustained in future periods. The main contribution of this study is the comparison of generic strategies based on the sustainability of firm performance. This aspect of the strategy-performance link has not been considered in prior work. Another contribution of the study is that it considers multiple dimensions of firm performance in order to evaluate the trade-offs involved with pursuing different strategies. In particular, the authors contribute to the literature by documenting that while differentiation leads to more sustainable earnings, it also leads to riskier and more unstable earnings.

A DEA-based stochastic frontier estimation framework is presented to evaluate contextual variables affecting productivity that allows for both one-sided inefficiency deviations as well as two-sided random noise. Conditions are identified under which a two-stage procedure consisting of DEA followed by ordinary least squares (OLS) regression analysis yields consistent estimators of the impact of contextual variables. Conditions are also identified under which DEA in the first stage followed by maximum likelihood estimation (MLE) in the second stage yields consistent estimators of the impact of contextual variables. This requires the contextual variables to be independent of the input variables, but the contextual variables may be correlated with each other. Monte Carlo simulations are carried out to compare the performance of our two-stage approach with one-stage and two-stage parametric approaches. Simulation results indicate that DEA-based procedures with OLS, maximum likelihood, or even Tobit estimation in the second stage perform as well as the best of the parametric methods in the estimation of the impact of contextual variables on productivity. Simulation results also indicate that DEA-based procedures perform better than parametric methods in the estimation of individual decision-making unit (DMU) productivity. Overall, the results establish DEA as a nonparametric stochastic frontier estimation (SFE) methodology.

Managerial ability and managerial efforts play key role in the performance of business enterprises. However, this indicator is not directly observable. The current paper focuses on estimating managerial ability in the context of the Indian and Iranian general insurance sectors. The study is based on 140 firm-year observations in India and 140 firm-year observations in Iran spread over 7 years (2012–13 to 2018–19). For measuring managerial ability, we have used a three-stage procedure that involves the estimation of insurer-wise efficiency using Data Envelopment analysis (DEA) in the first stage and then regression of the logarithm of technical efficiency on a set of explanatory variables. In the final stage, we have estimated managerial ability from regression residuals (the difference between the observed and fitted values of insurer efficiency). In order to test the validity of the relationship between return on equity and managerial ability we use the general additive model (GAM). Our results confirmed that there is a positive relationship between return on equity and managerial ability. Our findings also revealed that the mean technical and output allocative efficiencies and managerial ability of Iranian markets highly fluctuated with a high variance. In contrast, these indicators did not fluctuate much in India.

We investigate analytically and empirically the relationship between demand uncertainty and cost behavior. We argue that with more uncertain demand, unusually high realizations of demand become more likely. Accordingly, firms will choose a higher capacity of fixed inputs when uncertainty increases in order to reduce congestion costs. Higher capacity levels imply a more rigid short-run cost structure with higher fixed and lower variable costs. We formalize this \"counterintuitive\" argument in a simple analytical model of capacity choice. Following this logic, we hypothesize that firms facing higher demand uncertainty have a more rigid short-run cost structure with higher fixed and lower variable costs. We test this hypothesis for the manufacturing sector using data from Compustat and the NBER-CES Industry Database. Evidence strongly supports our hypothesis for multiple cost categories in both datasets. The results are robust to alternative specifications.

Accountants examine multiple indicators when assessing whether individual assets are impaired. Different indicators predict cash flows over varying time horizons, and their importance varies with how far into the future individual assets are expected to generate cash flows. We predict that earnings exhibits asymmetric timeliness with respect to multiple indicators, including stock return, sales change, and operating cash flow change, which differentially explain write-downs of current assets, long-lived tangible assets, and indefinite-lived goodwill. We predict an interaction effect between indicators, such that the total impact of several consistent indicators is greater than the sum of their individual impacts. Empirical estimates for U.S. firms are consistent with our predictions and yield new insights about the effects of multiple indicators for both conservatism and impairment research. Our multi-indicator asymmetric models also change inferences about the relative explanatory power of economic factors versus reporting incentives in asset impairments.

This study focuses on the relation between current compensation and past performance measures as signals of a chief executive officer's (CEO's) ability. We develop a simple two-period principal-agent model with moral hazard and adverse selection and test theoretical predictions using CEO compensation data from 1993–2006. Consistent with the predictions, we find that salary (bonus) is positively (negatively) associated with past performance for both continuing and newly hired CEOs. We also find that while current salary is positively associated with future performance, current bonus is not. As the model suggests, salary is adjusted to meet the reservation utility and information rent, and is positively correlated over time to reflect ability. Bonus serves to address moral hazard and adverse selection by separating highability agents into riskier contracts. Our results indicate that it is important to disaggregate cash compensation into salary and bonus components to understand the dynamic interaction between incentives and performance.

We evaluate the descriptive validity of the cost behavior model for profit analysis using Compustat data. For this purpose, we propose an earnings forecast model decomposing earnings into components that reflect (1) variability of costs with sales revenue and (2) stickiness in costs with sales declines. We evaluate the predictive ability of our model by benchmarking its performance in forecasting one-year-ahead returns on equity against that of two other time-series models based on line item information reported in the income statement and in the statement of cash flows. Specifically, we consider a model that disaggregates earnings into operating income and non-operating income components and another that disaggregates earnings into cash flows and accruals components. While all three models are less accurate than analysts' consensus forecasts that rely on a larger information set, we find that our model provides substantial improvement in forecast accuracy over the other two models that use only the line items in the financial statements. Finally, invoking the market efficiency assumption, we find that earnings forecast errors based on our model have greater relative information content than forecast errors based on the two alternative models based on financial statement information in explaining abnormal stock returns.

We investigate the association between firms’ strategy and their corporate social responsibility (CSR) performance and whether the alignment between strategy and CSR activities affects firms’ financial performance. We describe firms’ strategies as innovation differentiation, marketing differentiation, and cost leadership Miller, (1986). We expect a higher benefit from CSR for firms that rely more on innovation differentiation and a lower benefit for firms that rely more on marketing differentiation and cost leadership. We measure firms’ strategy through a textual analysis of 10-K filings and collect CSR data from KLD Ratings. We find that innovation differentiation strategy is positively associated with CSR performance, while cost leadership (marketing differentiation) is negatively (insignificantly) associated with CSR performance. Moreover, we find that innovating differentiators with higher CSR performance achieve higher financial performance. Finally, we provide additional evidence that information asymmetry and financial constraints moderate the alignment between firms’ strategy and CSR performance.

The balanced scorecard provides a framework for selecting multiple performance measures that supplement traditional financial measures with operating measures of customer satisfaction, internal processes, and learning and growth activities. An essential aspect of the balanced scorecard lies in its articulation of the linkage between performance measures and business strategy. This study conducts an experiment to assess how individuals' evaluations of the performance of business unit managers depend on strategically linked performance measures of a balanced scorecard. Statistical test results indicate that performance evaluations are influenced by strategically linked measures more than non-linked measures only when evaluators are provided detailed information about business unit strategies. The results also confirm Lipe and Salterio's (2000) finding that evaluators rely more on common measures than on unique measures. Evaluators rely more on strategically linked measures than on common measures when they are provided information on strategic linkages, but the reverse relation holds when they are not.

In this paper, we investigate the stock market valuation of the intangible asset created by selling, general, and administrative (SG&A) expenditure. Although GAAP requires immediate expensing of SG&A, prior studies show that current SG&A generates future economic benefits, suggesting that it creates an intangible asset. We find that the contemporaneous stock market seems to recognize some of the intangible asset value implicit in SG&A. Positive subsequent returns can be earned in firms with a high SG&A intangible asset value. These excess returns are more likely due to investor mispricing than to risk compensation. Furthermore, we find that both analysts' long-term growth forecast revisions and one-year-ahead forecast errors are positively associated with the future value created by current SG&A, indicating that analysts partially incorporate the intangible SG&A asset value into their forecasts. Overall, the evidence suggests that the capital market only partially recognizes the intangible asset value created by SG&A expenditure.