Business strategy and systematic risk: Evidence from China

• Published date: 01 October 2021
• Author: Md Jahidur Rahman,Lantian Jia,Rakiba Sultana
• Date: 01 October 2021
• DOI: http://doi.org/10.1002/jcaf.22514

Received:  July Accepted:  July 

DOI: ./jcaf.

RESEARCH ARTICLE

Business strategy and systematic risk: Evidence from China

Md Jahidur Rahman1Lantian Jia2Rakiba Sultana1

Wenzhou-KeanUniversity, Wenzhou,

China

Stevens Institute of Technology,

Hoboken, New Jersey, USA

Correspondence

MdJahidur Rahman, Wenzhou-Kean

University,Wenzhou, China.

Email:mdjahidr@kean.edu

Abstract

Guided by their business strategies, firms develop their competitive advantages

and overcome systematic risks by allocating their limited resources. This study

explores how advertising, labor, R&D, cost, and capital intensities are corre-

lated with the systematic risks of  industries in the Chinese market. The

results show that these correlations vary between industries. To easily adapt to

market variations and reduce systematic risks, decision-makers are advised to

design their business strategies according to the characteristicsof their respective

industries.

KEYWORDS

business strategy, systematic risk, R&D intensity, advertising intensity, capital intensity, labor

intensity, cost intensity

JEL CLASSIFICATION

D, D, G, L, L, L, M

1 INTRODUCTION

Firms generally adopt strategies to fulfill the demands of

their shareholders, improve their performance, enhance

the sustainability of their business, and obtain other com-

petitive resources, such as R&D, advertising, and labor.

In formulating those strategies, firms typically identify

their strengths and weaknesses. Depending on their eco-

nomic, social, and political environments, firms also face

various systematic risks, such as interest and exchange

rates, national policies, purchasing power fluctuations,

and macroeconomic factors. Therefore, to adapt to market

variations and reduce systematic risks, firms should con-

sider industry characteristics when formulating their busi-

ness strategies.

In their pioneering work on systematic risk, Mont-

gomery and Singh () argued that risk is significantly

correlated with strategy. Later, Barton ()proposed

that systematic risk is influenced by diversification strate-

gies. Among the factors that potentially influence system-

atic risks, firms’ R&D, capital, and advertising intensities

have received the most attention, with researchers typi-

cally finding that capital and advertising intensities are

negatively correlated with systematic risk. Although busi-

ness and operating theories posit a positive relationship

between R&D intensity and systematic risk, researchers

have yet to reach a consensus on this topic.

To help decision-makers formulate effective business

strategies, this study probes the effects of firms’ R&D,

labor, capital, costs, and advertising intensity on system-

atic risk in the Chinese market. Two research questions

are put forward: how do businessresource intensities affect

systematic risk and its constituents, and do these effects

differ between industries? Exploring these questions can

generate useful insights into how firms’ resource alloca-

tion strategies can reduce their exposure to systematic

risks.

China established its capital market in  and has

since expanded its influence across Asia, Central and

Eastern Europe, Africa, and Latin America. The Chinese

stock market significantly affects those of other Asian

economies. International investors are generally attracted

J Corp Account Finance. ;:–. © Wiley Periodicals LLC99wileyonlinelibrary.com/journal/jcaf

100 RAHMAN  .

to the stock markets of emerging economies, given the

diversification benefits they provide, and this is especially

true in the Chinese market (Hung, ). Therefore, con-

sidering its growing importance, the characteristics and

operating mechanisms of the Chinese stock market war-

rant further investigation. Therefore, this study focuses on

companies listed on the Chinese stock market to answer its

research questions.

The – data of Chinese A-share firms are cate-

gorized into the following Global Industry Classification

Standard (GICS) sectors: real estate, energy, financials,

materials, information technology, industrials, communi-

cation services, consumer discretionary, healthcare, con-

sumer staples, and utilities. After data cleaning, renowned

market models are used to conduct a preliminary analy-

sis of the firms’ advertising, capital, R&D, cost, and labor

intensities. These results are then used to decompose the

correlations into three constituents: intrinsic business risk,

the degree of financial leverage (DFL), and the degree of

operating leverage (DOL). This decomposition facilitates

the exploration of those factors that contribute to system-

atic risks.

Seven trends are identified, two of which are particularly

important to the formulation of business strategies. First,

there are strong and positive correlations in the energy,

healthcare, and industrials sectors (implying that bene-

fits should be balanced with risks). Second, there are sig-

nificantly negative correlations in other sectors, including

the real estate and financial sectors (which equate greater

resource intensities with lower risks). These trends are

then verified against the current situation in the Chinese

market. The constituents of systematic risk are also decom-

posed to easily identify the main constituents of resource

intensity.

To the best of the author’s knowledge, this paper is the

first to examine how resource intensities affect system-

atic risk and its constituents and how these effects vary

between industries in China. The findings can help firms

design their resource allocation strategiesto reduce the sys-

tematic risks they face. Moreover, although previous stud-

ies have generally focused on one or two factors in the

United States market, this paper simultaneously explores

five resource intensities in various sectors. Business strat-

egy suggestions are put forward according to the current

situation in the Chinese market. Investors and firms may

benefit from the findings, as they can help predict the risks

firms face when intensifying or weakening their resource

allocation in response to market trendsand thus help f irms

make appropriate investment decisions.

The rest of this paper is organized as follows. Section 

reviews the literature and proposes the research hypothe-

ses. Section discusses the methodological framework.

Section presents the results. Section discusses the

results and concludes the paper.

2LITERATURE REVIEW AND

HYPOTHESIS DEVELOPMENT

2.1 R&D intensity and systematic risk

Firms must invest in R&D to survive in the market;accord-

ingly, corporate executives prioritize increasing R&D

intensity and acknowledge its significant contribution to

earnings and stock returns (Coles et al., ). Although

investing in R&D may negatively affect a firm’s quar-

terly financial performance (Andras & Srinivasan, ),

a study that tracked  US firms from  to 

revealed that on average, each % of R&D expense input

leads to a .% increase in market-to-book ratio (Pearl,

). Further studies have found that firms specializing in

consumer products have lower R&D intensities compared

with manufacturing firms and that their profit margins are

positively related to their R&D intensity (Andras & Srini-

vasan, ). Future stock returns are also positively asso-

ciated with the ratio of R&D capital to market value (Lev

& Sougiannis, ). Likewise, the volatility of returns has

been positively linked to R&D intensity (Chan et al., ).

As greater risk may lead to higher returns, the systematic

risk firms face may be aggravated by the risks inherent in

R&D; however, R&D improvesthe dynamic eff iciency and

flexibility of firms operating in sluggish markets (Miller &

Bromiley, ).

In recent years, China has adjusted the mode of its

economic development model from extensive to intensive

growth. An empirical analysis of a sample of high-tech

enterprises from Shanxi revealed that firms’ systematic

risks increase with their R&D intensity; in addition, R&D

intensity is positively correlated with intrinsic business

risk but is not significantly correlated with either the DOL

or DFL (Zhang & Jiang, ). In the same vein, Kothari

et al. () reported that by increasing the unpredictabil-

ity of future cash flows, R&D investment exposes firms to

additional risks, including systematic risks.

The relationship between R&D and risk in the United

States is still being debated. Forinstance, although Ho et al.

() argued that R&D intensity is positively related to

systematic risk, greater systematic risk is mainly caused by

greater intrinsic business and operating risks, not the DOL

or DFL. Meanwhile, McAlister et al. () argued that

firms listed on the NYSE can reduce their systematic risk

by investing in R&D.In sum, R&D intensity benefits multi-

ple aspects of firm performance and consequently reduces

systematic risk, benefiting shareholders.