Industry window dressing

Chen, Huaizhi, Cohen, Lauren and Lou, Dong ORCID: 0000-0002-5623-4338 (2013) Industry window dressing. Financial Markets Group Discussion Papers (719). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We explore a new mechanism through which investors take correlated shortcuts. Specifically, we exploit a regulatory provision governing firm classification into industries: A firm's industry classification is determined by the segment that has the majority of sales. We find strong evidence that investors overly rely on this primary industry classification. Firms just above the industry classification cutoff have significantly higher betas with respect to, as well as more sector mutual fund holdings and analyst coverage from, that industry, compared to nearly identical firms just below the cutoff. We then show that managers undertake specific actions to exploit investor shortcuts. Firms around the discontinuity point of 50% sales are significantly more likely to have just over 50% of sales from a "favorable" industry. Further, these firms just over the cutoff have significantly lower profit margins and inventory growth compared to other firms in the same industries, consistent with these firms slashing prices to increase sales. These same firms, however, do not exhibit different behaviors in any other aspect of their business (e.g., CapEx or R&D), suggesting that it is not a firm-wide shift of focus. Last, firms garner tangible benefits from switching into favorable industries, such as engaging in significantly more SEOs and stock-financed M&As.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2013 The Authors
Divisions:	Systemic Risk Centre Finance
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G0 - General > G00 - General G - Financial Economics > G1 - General Financial Markets > G10 - General G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
Date Deposited:	08 Jun 2023 15:27
Last Modified:	01 Oct 2024 04:04
URI:	http://eprints.lse.ac.uk/id/eprint/119035

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