Relative Performance Ranking: Insights into Competitive Advantage

• In Event: Novel Topics in Financial Accounting

Abstract

We examine how changes to the firm’s competitive advantage are manifested in the firm’s financial statements and how market participants react to these changes. We argue that changes to the firm’s competitive advantage are manifested through changes to the firm’s intra-industry performance ranking (measured using return on equity). We find that changes to the firm’s performance ranking are positively associated with earnings persistence, consistent with the sustainability of profits increasing when the firm’s competitive advantage improves. We then provide evidence consistent with investors and analysts positively valuing improvements to the firm’s performance ranking, especially when the firm’s ranking has been stable in the recent past. In fact, our evidence suggests that investors and analysts react more strongly to a change in the firm’s performance ranking than the firm’s earnings surprise. We also find that the effect of changes in performance ranking on earnings persistence is stronger when the firm’s ranking has been stable in the past. Our results suggest that the firm’s performance ranking within the industry constitutes an additional and relevant performance benchmark for investors and managers that has not been explored by prior research. This evidence also suggests that investors use the entire distribution of earnings to evaluate a firm’s performance and not just analyst expectations or the prior period’s performance.

Authors

• Hojun Seo, Washington University in St. Louis

• Jared Jennings, Washington University

• Mark Soliman, University of Southern California