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Testing for Persistence of Profits’ Differences Across Firms

2008; Taylor & Francis; Volume: 15; Issue: 2 Linguagem: Inglês

10.1080/13571510802134353

1466-1829

John Cable, Dennis C. Mueller,

Innovation and Knowledge Management

Abstract Abstract We review the logic and implications underlying both static and dynamic models of competition, and associated tests of competitive effectiveness. Complications arising due to innovation, mergers and cyclical factors are discussed. Points raised in the theoretical discussion are illustrated with case histories and estimates for a number of US and UK companies. The empirical analysis tests a larger set of models than has been used in most previous work, and uses longer time series of company profits. We conclude that the patterns of profits observed in both countries are consistent with a larger and more complicated set of models of the competitive process than has been assumed until now, and that further work remains to be done in clarifying both why some firms are persistently profitable, and the nature of the 'shocks' that appear to produce structural breaks in the time series of companies' profits. Key Words: Profit PersistenceCompetitionStructural Time SeriesJEL Classifications: L12C32 Notes 1. See, for example, Geroski and Jacquemin (1988 Geroski, P. and Jacquemin, A. 1988. The persistence of profits: a European perspective. Economic Journal, 98: 375–89. [Crossref], [Web of Science ®] , [Google Scholar]), Mueller (1990 Mueller, D.C., ed. 1990. The Dynamics of Company Profits, Cambridge: Cambridge University Press. [Crossref] , [Google Scholar]), Kambhampati (1995 Kambhampati, U.S. 1995. The persistence of profit differentials in Indian industry. Applied Economics, 27(4): 353–61. [Taylor & Francis Online], [Web of Science ®] , [Google Scholar]), Goddard and Wilson (1999 Goddard, J.A. and Wilson, J.O.S. 1999. The persistence of profit: a new empirical interpretation. International Journal of Industrial Organization, 17(5): 663–87. [Crossref], [Web of Science ®] , [Google Scholar]), Glen et al. (1999 Glen, J. 1999. "How intensive is competition in the emerging markets? 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These have been explicitly introduced in some empirical work, and did not account for all differences in estimates of πip (Mueller, 1986 Mueller, D.C. 1986. Profits in the Long Run, Cambridge: Cambridge University Press. [Crossref] , [Google Scholar], Ch. 4). 10. For technical details of structural time series methods and Stamp, see Harvey (1990 Harvey, A.C. 1990. The econometric analysis of time series , (2nd edn), Cambridge, MA: MIT Press. [Google Scholar], 1997 Harvey, A.C. 1997. "Linear regression in the frequency domain". In Time Series Models, Causality and Exogeneity, Edited by: Hamouda, O.F. and Rowley, J.C.R. 490–95. Cheltenham: Edward Elgar. [Google Scholar]) and Koopman et al. (2000 Koopman, S.J. 2000. Stamp: Structural Time Series Analyser, Modeller and Predictor, London: Timberlake Consultants Ltd.. [Google Scholar]). A brief summary may be found at Appendix 2 of Cable and Jackson (2008 Cable, J.R. and Jackson, R.H.G. 2008. 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"Scottish & Newcastle PLC". In International Directory of Company Histories, Edited by: Grant, T. Vol. 35, 394–97. Detroit, MI: St. James Press. update, S. Brynildssen [Google Scholar] (Scottish & Newcastle). 12. Tied houses were typically owned by a brewery and run by tenants or managers under exclusive trading arrangements, thus providing significant forward vertical integration with security of market and varying degrees of control over prices for the brewer. 13. Off‐licences are specialist outlets, now mainly national chains, with a licence to sell beer, wines and spirits for consumption off the premises only. 14. Recall that a λ of 0.6 implies only 20% of rents surviving after three years and less than 10% after five, with comparable figures of 3% and less than 1% for λ = 0.3. 15. Bounded by d L = 1.373 and dU = 1.502 in these cases. 16. Tables with appropriate diagnostics are available from the authors on request. 17. While proceeding to autoregressive processes of order three or higher is easy from the point of view of estimation, and might in theory accommodate more complex cyclical patterns, deducing the parametric conditions for cyclical behaviour becomes increasingly complex. 18. The relevant χ 2 statistics under Wald tests are 14.72 and 2.41respectively. 19. However, the Rank case was the third most successful instance among the 53 cases analyzed. In only 15 of these was b 2 numerically less than c, and in only one of those was the difference significant at 5%, with one other at 10%, Rank being the only other case approaching significance at that level. For our other UK illustrative cases, Glaxo was one of those for which the estimate of b 2 was numerically greater than c, thus failing the first condition for harmonic behaviour. While this condition was met in the cases of Boots and S&N, the differences were significant at only 29 and 28%. 20. The relevant χ 2 values are 5.24 and 28.09. The preferred STS specification in this case is the local linear trend model, in which both level and slope are stochastic, as opposed to fixed and stochastic respectively in the 'smooth trend' model, which is our usual STS starting point. 21. Further interventions, e.g. for 1969, 1976 and 1983, are not significant and generally produce less satisfactory results, indicating a degree of robustness in the preferred model. 22. Somewhat surprisingly, rich harmonics also emerged in the case of Boots, and lesser evidence of cycles was also uncovered for some of the other firms. However, their profit histories seem to be well accounted for with the AR1 model appropriately modified to allow for structural breaks. Therefore, we do not pursue the cyclical aspect further. We note, however, that, where cycles exist, STS appears to have a definite edge over the AR1 in detecting and describing them. 23. As long as, in the case of Glaxo, difficulties at the time of writing again prove transitory. Glaxo (now Glaxosmithkline, after the merger with Smithkline Beecham in 2000)) encountered problems in the last two to three years over executive compensation; litigation concerning the reporting of research findings; and in discovering replacements for major drugs going out of patent. On 31 July 2006, Boots merged with Alliance UniChem. 24. Mueller (1997 Mueller, D.C. 1997. Merger policy in the United States: a reconsideration. Review of Industrial Organization, 12(5–6): 655–85. [Crossref], [Web of Science ®] , [Google Scholar]) used πip estimates from the period of 1950 to 1972 to predict profit deviations from the mean in 1993–94. He found that the sample of firms with estimated πip s ≥ 0.5 had a much higher probability of surviving until 1994, and had a mean π of 0.45. Firms with estimated πip s ≤ −0.5 had a lower probability of surviving, and a mean π of −0.72.