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Title: Impact of Sustainable Growth on Stock Returns and Systematic Risk: An Empirical Study on Indian Manufacturing Firms
Authors: Arora, Lalit
Supervisor: Kumar, Shailendra
Verma, Piyush
Keywords: Sustainable growth;Asset growth;Stock returns;Systematic risk;Panel VAR model;Manufacturing;India
Issue Date: 6-Jul-2018
Abstract: While traditional measures of a firm’s success have focussed more on rubrics like sales and profitability, several firm managers, venture investors and researchers have come to acknowledge the need of contemporary and more appropriate measures of firm success due to the change the business environment has undergone in the last few decades. The hurdles and problems faced by businesses today are different from the challenges faced by firms say, two decades ago. Thus, identification of other more appropriate firm performance measures has received much attention of stakeholders, and measures like firm growth have come to be recognized as a superior measure of firm success. The issue related to appropriateness of different growth measures as firm success parameters has been addressed by a number of researchers (Lockwood & Prombutr, 2010; Yao, Yu, Zhang, & Chen, 2011; Li, Becker, & Rosenfeld, 2012). Various studies have focused on growth related performance measures to address new metric needs. For example Cooper, Gulen, & Schill (2008) studied the impact of asset growth on stock returns. Buenafe, Bohnett, & Patrick (2009) studied the impact of economic growth on performance of firms. Long term output growth was found to have a significant positive relationship with stock performance (Lee, 1996). Undoubtedly, studies have provided a firm theoretical base to examine these relationships using past growth rates of firms. However, finance literature seems to lack substantially when it comes to an examination of growth that firm can achieve in the future. I seek to make a contribution with this effort to fill this gap in this growing literature base. I built my effort to reconcile discussions related to the impact of different variables depicting firm performance on firm stock returns and risk. Since managers and investors are more concerned about the future growth prospects of firms, I add to the literature by incorporating a less used but no less important firm performance indicator in the form of Sustainable Growth Rate (SGR) to establish a relationship with stock returns and systematic risk. SGR is the “maximum rate at which a firm’s sales can increase without depleting financial resources” (Higgins, 2007). I built my methodological approach on studies describing the calculation of SGR. These include: Babcock (1970); Higgins (1977 & 1981); Johnson (1981); Jarvis, Mayo, & Lane (1992); Mayo & Jarvis (1992); Harkleroad (1993); Platt, Platt, & Chen (1995); Firer (1995); Ashta (2008); and Angell (2011). Though, the concept of SGR is not new and frequently appears in finance literature, it is yet to be systematically applied as a firm growth method. An effective and appropriate method of calculation of SGR remains elusive, and further examination of factors affecting this growth rate is required. I seek to address these issues by exploring the determinants of SGR and proposing a suitable method to determine this growth rate. To the best of my knowledge, the literature on asset pricing (except Lockwood & Prombutr, 2010) has so far neglected the ability of SGR to explain stock returns and systematic risk. I provide systematic evidence to issues related to calculation of SGR and impact of this growth measure on firm stock returns and risk and these qualify as my major contributions to the literature. I examine the determinants of SGR and propose a suitable method of its calculation. Results suggest that Angell’s (2011) formula considering key ratios like return on equity (ROE) and profit retention ratio (RR) is effective in capturing the variations in SGR. The results hold even after introducing industry specific factors like industrial growth and inflation in the regression equations. SGR calculated only on the basis of percentage change in book value of equity provides an aggregate view depicting that any changes in this growth rate across industries are random. Many researchers contend the ability of accounting and macro economic variables to affect stock returns (Graham & Dodd, 1934; Gordon, 1962; Rosenberg, Reid, & Lanstein, 1985; Ou & Penman, 1989; Fama & French, 1992; Fieberg, Varmaz, & Poddig, 2016) and firms’ systematic risk (Beaver & Manegold, 1975; Bowman, 1979; Hamid, Prakash, & Anderson, 1994; Hong & Sarkar, 2007; Rowe & Kim, 2010). Yet, existing literature has been unable to bring forth any evidence of the existence of a causal relationship between indicator of future growth potential in the form of SGR and firms’ stock returns and systematic risk. I have focused on a phenomenon that has escaped the notice of researchers up to this point. I demonstrate a suitable method of SGR calculation and highlight the factors affecting this growth rate. I also highlight the existence of a causal relationship of SGR with firm stock returns and systematic risk. By providing insight on how various aspects associated with firm growth are related to returns and risk, I add to existing literature on asset pricing. My study provides evidence that higher SGR firms tend to have higher stock returns. This means that SGR is adequately priced.
Description: Doctoral Thesis
Appears in Collections:Doctoral Theses@LMTSM

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