Productivity, risk, and expected stock returns

• Published date: 01 April 2023
• Author: Roi D. Taussig
• Date: 01 April 2023
• DOI: http://doi.org/10.1002/jcaf.22598

Received: 23 May 2022 Accepted: 8 August 2022

DOI: 10.1002/jcaf.22598

RESEARCH ARTICLE

Productivity, risk, and expected stock returns

In memory of Simon Benninga

Roi D. Taussig

Department of Economics and Business

Administration, Ariel University, Ariel,

Israel

Correspondence

Roi D. Taussig,Department of Economics

and Business Administration, Ariel

University, Ariel 40700,Israel.

Email: roit@ariel.ac.il

Abstract

This study suggests a new measure of productivity for production factors. Adjust-

ment costs for capital-intensive firms are higher than for labor-intensive firms

(the differences are systematic). Therefore, higher changes in capital relative to

labor will induce higher risk. The capital/labor ratio has been studied extensively.

However,the new measure is based on other items, which facilitate the marginal

changes in capital and labor,rather than quantities. When the elasticity of capital

to labor (ECL) is higher, stock returns are significantly higher as well. This is true

both statistically and economically.

KEYWORDS

asset pricing, cross-section returns, productivity, stock return

JEL CLASSIFICATION

G11, G12, G13, G14, G17

1 INTRODUCTION

For decades, the efficiency of production to maximize

profits has been extensively studied in economics and

finance (e.g., Arrow et al. (1961)). Adjustment costs

associated with new plant and equipment for capital-

intensive firms are systematically higher than for labor-

intensive firms (Chakrabarti, 2009). This implies that

higher changes in capital relative to labor induce higher

risk, and therefore should explain higher stock returns.

This study proposes a new measure for the Elastic-

ity of Capital to Labor (ECL). While former measures

referred to quantities of capital and labor, the new mea-

sure refers to marginal changes of capital and labor.

This study investigates 35,504 US firm-year observations

and finds that higher ECL explains higher stock returns.

The relation is strong both statistically and economi-

cally. To check robustness, this relationship was examined

by performing out-of-sample tests, which also indicated

significance.

2LITERATURE REVIEW AND

HYPOTHESIS DEVELOPMENT

The most well-known asset pricing model is the Capital

Asset Pricing Model (CAPM; Black, 1972; Lintner, 1965;

Sharpe, 1964), which employs the coefficient of system-

atic risk (Beta) to explain the expected returns on risky

assets. However, Fama and French (1992)presentCAPM

anomalies, including Size or market capitalization (Banz,

1981)andBook-to-Market (Rosenberg et al., 1985;Stattman,

1980). Moreover,they prove that Beta is insignificant when

controlling for Size. For decades, further anomalies have

emerged, such as momentum and past performance as

in Jegadeesh and Titman (1993). According to Vo and

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