Firm efficiency and the investment anomalies

Purpose The purpose of this paper is to investigate whether firm efficiency can explain the investment anomaly. The investment anomaly refers to the persistent negative relation between firm growth and future risk-adjusted returns. When firms grow by investing heavily, the market often takes the growth as positive news initially but will correct prices downward subsequently if the firms lack skills to materialize value from the investments. Design/methodology/approach The author conducts portfolio sorting and Fama-Macbeth regression analyses with three different measures of efficiency and four variables for firm investment: net stock issuance (NSI), total asset growth (dAA), fixed asset and inventory growth (IA) and net operating assets (NOA). Findings The author finds that the NSI, dAA and IA anomalies are concentrated in firms with low overall efficiency. In addition, there is strong evidence that manager-driven efficiency is closely related to the NSI anomaly and limited evidence that NOA efficiency plays a role in the NSI, IA and NOA anomalies. Originality/value The research contributes to the literature by employing advanced efficiency measures developed by Demerjianet al.(2012) to resolve extant asset pricing puzzles. Also, the findings offer important implications for corporate managers and investors by demonstrating the effect of firm investments and efficiency on future profitability of stocks.