Market competition, government efficiency, and profitability around

the world

Paul Healy, George Serafeim, Suraj Srinivasan and Gwen Yu

Harvard Business School

May 2011

Abstract

We examine how cross-country differences in product, capital, and labor market

competition, and government efficiency affect the rate of mean reversion of corporate
profitability. Using a sample of 42,337 unique firms from 49 countries, we find that
corporate profitability mean reverts faster in countries where product and capital markets
are more competitive. Moreover, holding constant product, capital, and labor market
competition we find that profitability mean reverts faster in countries with less efficient
governments. The findings suggest that country-level factors have an economically
significant impact on the rate of corporate profitability mean reversion. The study has
implications for forecasting profitability and equity valuation in a global context.


We thank seminar participants at UC Berkeley and Tilburg University for comments, and Krishna Palepu
for many valuable discussions. We gratefully acknowledge financial support from the Division of Research
of the Harvard Business School. All errors are our own.

Electronic copy available at: http://ssrn.com/abstract=1865878

I. Introduction

This paper tests whether mean reversion in corporate profitability varies systematically

across countries. We hypothesize that the degree of competition in a country’s product,

capital, and labor markets, and its government efficiency affect the rate of mean reversion

of corporate profits.

One of the strongest propositions of economic theory is that in competitive

economies new entrants compete away economic rents (Stigler 1961). As a result, in a

general equilibrium framework, firms with either superior or subnormal profits are

expected to exhibit convergence towards the mean (e.g., Arrow and Debreu, 1954). This

proposition has motivated a large literature in management to search for factors that

enable firms to enjoy a sustainable competitive advantage and mitigate economic

pressure for mean reversion (Porter 1980, 1985; Lippman and Rumelt, 1982; Wiggins

and Rueffli, 2002; Hoskisson et al., 2000).

Understanding whether and how corporate profitability mean reverts across

countries is important for valuation purposes. The accounting based valuation model

implies that the ratio of a firm’s economic value to book value is determined by its ability

to generate book returns in excess of its cost of capital (Ohlson 1995). Thus, the speed of

mean reversion of excess returns is critical in estimating forecast horizons and terminal

values in valuation (Healy, Palepu, and Bernard 2000; Penman 2006). Allowing forecast

horizons and terminal values to vary across countries based on the effectiveness of their

market institutions is therefore likely to allow investors and financial intermediaries to

make more accurate valuation estimates.

Electronic copy available at: http://ssrn.com/abstract=1865878

 There are two reasons to expect that country-level factors are important drivers of

mean reversion in profitability. First, legislation in factor markets that characterize the

level of competition is typically determined at the country-level (La Porta et al. 1998,

Doidge et al. 2007). These include regulations that determine government subsidies and

import tariffs, labor regulations, and financial liberalization. Such regulations directly

affect the ease with which firms are able to sustain abnormal profits. Second, the

institutions that govern business activities and affect entrepreneurs’ incentives to innovate

and enter new markets are typically established at the country-level (Caves 1989; Porter

1990; Khanna and Palepu 1997; North 1990). In this paper we use four metrics to capture

the strength of different institutions and regulatory regimes expected to influence the

mean reversion of profitability: product, capital, and labor market competition, and

government efficiency.

To test our predictions, we use a sample of 42,337 unique firms from 49 countries

in the period 1997 to 2008. The intertemporal dynamics of corporate profitability are

analyzed using a partial adjustment model (Fama and French 2000) that examines

changes in profitability as a function of prior years’ unexpected profitability. Our analysis

uses firm-year level data to examine how country measures of factor market competition

and government efficiency affect the mean reversion of Return-on-Equity (ROE). Firm-

level observations allow us to control for firm and industry characteristics that prior

studies have shown to affect the speed of mean reversion in earnings.

The results confirm that there is predictable variation in mean reversion in

corporate performance across countries. Mean reversion is faster in countries with more

competitive product and capital markets. Holding firm and industry characteristics

Electronic copy available at: http://ssrn.com/abstract=1865878

constant, an inter-quartile increase in the product or capital market competition of the

home country of the firm increases mean reversion by approximately 4.5% (for example

from 28% to 32.5%). Mean reversion is also faster in countries with more competitive

labor markets with an inter-quartile effect of 3.1%. Government efficiency is not

significantly related to mean reversion.

When we consider all country variables simultaneously we find that product and

capital market competition are significantly related to mean reversion, but not labor

market competition. An inter-quartile increase in a firm’s home country product (capital)

market competition increases mean reversion by 5.3% (4.4%). After controlling for

product, capital, and labor market competition, we find that firms in countries with more

efficient governments exhibit slower profitability mean reversion, consistent with more

efficient governments lowering the risk of appropriation. An inter-quartile increase in

government efficiency lowers mean reversion by 4.3%.

To examine the robustness of our results, we perform the analysis at the country-

year level. Annual estimates of country mean reversion are regressed on annual ratings of

country product, capital and labor market competitiveness, government efficiency, as

well as firm control variables that are aggregated at the country level. The results are

generally consistent with those reported for our primary specification - both higher

product and capital market competition are associated with faster mean reversion and

government efficiency with slower mean reversion.

In summary, our findings suggest that country-level factors, notably capital and

product market competition, affect the rate of mean reversion of corporate profitability.

These results complement earlier research on mean reversion in profitability that focuses

3
on firm (Nissim and Penman 2001) and industry level factors (Lev 1983; Fairfield et al.

2009). Our findings indicate that the institutional characteristics of the country in which

firms operate should also be considered when forecasting future firm performance.

The rest of the paper proceeds as following. We develop our hypothesis in

Section II and describe the research design in Section III. Section IV discusses the data

and Section V the results. Section VI concludes.

II. Hypothesis development and prior literature

A long stream of accounting literature documents the mean reverting property of

corporate profits. Beaver (1970) is the first study to show that firms with high ROE

experience a decrease in ROE in subsequent periods, while firms with low ROE

experience an increase in subsequent periods, but at a slower rate than the decrease of

high ROE firms. Penman (1991) shows that while corporate profit is mean reverting, it

also includes a persistent component which allows high ROE firms to continue to

outperform in the future.

The rate at which profits mean revert is of great interest because equity values are

based on current profits which are likely to sustain in the future (Freeman et al. 1982).

Ohlson (1995) provides a valuation framework that links equity values to profit

persistence and shows how equity price can be stated as a linear combination of book

value and current profits weighted by its persistence. Under minor simplifying

assumptions, more persistent profits obtain a larger pricing multiple while purely

transitory profits have little impact on a firm’s stock price. This finding implies that the

persistence of corporate profitability has a direct effect on equity valuation. Numerous

4
studies have followed to understand the various drivers that determine the time-series

properties of corporate profits (see Korthari 2001 for a review).

Prior studies find that mean reversion in corporate profits differ as a function of

both firm and industry-level characteristics. Firm-level determinants include firm size

(Lev 1983), future investment opportunities (Nissim and Penman 2001), as well as

accounting measurement errors (Penman and Zhang 2002). Cheng (2005) shows that

persistence for large firms can be explained in part by product differentiation and market

shares (measured using R&D and advertising intensity) suggesting that the industry

structure in which the firm operates affects the persistence of firm performance (Waring

1996). Consistent with this, Lev (1983) finds that industry barriers-to-entry, product type,

and degree of capital intensity can partially explain persistence in ROE.

Our study differs from these studies by examining how country-level factors

affect the persistence of corporate performance. Our main prediction is that the rate of

mean reversion of corporate performance will vary across countries, and this variation

will systematically relate to how the country’s institutions promote competition in

domestic factor and product markets. For an individual firm, mean reversion reflects the

rate at which abnormal performance dissipates and converges to an economy-wide mean.

Although firms seek to sustain any competitive advantage and resist mean reversion

(Schumpeter 1942; Porter 1985), they are typically subject to the economic laws of

competition (Aghion et al. 2001, Aghion 2002). This leads firms that generate superior

performance to face competition from new entrants, reducing future rents. Similarly,

under-performing firms are obliged to improve in order to survive, or to fail, leading to

profitability mean reversion.

5
 There are many reasons to believe that mean reversion of abnormal profits is

driven by country-level factors. First, legislation in factor and product markets that

characterize the level of competition is often determined at the country-level (Nickell and

Layard 1999). Tariffs on imports vary by country, as do immigration and employment

laws that determine labor flows. Most market reforms that affect the level of competition,

such as trade and financial liberalization, are enacted at the country-level (Claessens,

Ueda, and Yafeh 2010). Such regulations directly affect the ease with which firms are

able to sustain abnormal profits.

In addition, the institutions that govern business activities and affect

entrepreneurs’ incentives to innovate and enter new markets are established at the

country-level (La Porta, Lopez-de-Silanes, and Shleifer 1998). For example, in countries

where institutions enforce strong property rights entrepreneurs have incentives to take

risks, whereas entrepreneurs in countries with weak property rights are often reluctant to

enter contractual relationships due to the risk of knowledge expropriation. In other words,

sound institutions that protect business activities from expropriation and facilitate

efficient resource allocation ensure that competitive market forces function well.1

In this study, we focus on country-level factors that relate to the level of

competition in different markets in which firms operate in the course of doing business.

Specifically, we examine competition in the markets for factor inputs (i.e., the labor and

capital markets) and outputs (i.e., the product market). We also consider government

1
Although individual entrepreneurs also have incentives to voluntarily enforce property rights (Jensen and
Meckling 1976), the effectiveness of a given firm’s enforcement weakens absent a credible commitment
device. Consistent with this, studies find that predominantly country-level variables explain firms’
corporate governance practices (Doidge et al. 2007). We argue that this is because the institutions that
enforce the rule of law are determined at the country-level.

6
efficiency, which reflects government activities and ability to promote competition within

a country. Next, we discuss how competition in each market affects the mean reversion of

corporate performance.

Product market factors: Porter (1980) describes how barriers to entry (e.g. scale

economies, first mover advantage, legal barriers, and access to distribution) affect

product market competition. Profitable firms that face low barriers to entry are expected

to see their profits eroded as new entrants or existing players compete away their rents,

leading to mean reversion in profitability. Similarly, firms with underperforming business

segments are likely to exit the market in search for higher returns, also leading to faster

mean reversion of performance. Therefore, we predict that product market competition

will increase the speed of corporate performance mean reversion.

There are many reasons why product market competitiveness is likely to vary

across countries. First, many countries impose direct entry barriers to their domestic

goods markets in the form of trade barriers and tariffs. Such legislation causes cross-

country differences in market opportunities for foreign entrants. Second, legislation can

promote or stifle competition within each country. In our empirical analysis, we examine

variables that capture the existence of tariff barriers and openness to foreign competitors,

as well as the existence of legislation that facilitates business start-ups and promotes

domestic competition (see the Appendix for a list of all variables used).

Capital market factors: We predict that an efficient capital market will lead to faster

mean reversion of abnormal profits by facilitating resource allocation to the highest value

in use. The capital market allocates resources to entrepreneurs who often have profitable

investment opportunities, yet face financial constraints (Wurgler 2000). A well-

7
functioning capital market provides capital for new entrants that see opportunities to

compete effectively with profitable incumbents, thereby hastening mean reversion in the

incumbent’s profits. At the same time, efficient capital markets discourage firms from

investing in negative NPV projects (Morck, Wolfenzon, and Yeung 2005) and facilitate

the restructuring or closure of under-performing firms, again accelerating mean reversion.

Capital market efficiency is, therefore, an important contributor to country growth (Rajan

and Zingales 1998).

We examine various country-level measures of the efficiency of the domestic

capital market and related institutions in performing this allocation role. Following prior

literature, we measure the efficiency of a country’s capital market using the size and

liquidity of the domestic equity and bond markets, and other qualitative measures of

investor protection and shareholder rights (La Porta, Lopez-de-Silanes, and Shleifer

1998). Moreover, we take into account measures of financial institutions’ transparency

and effective regulation, and the availability of capital by alternative sources such as

venture capital.

Labor market factors: Labor is an important factor input to a firm’s production function.

In well-functioning labor markets, new firms that seek to challenge successful

incumbents are able to attract labor at a competitive price. In contrast, if the labor market

is effectively closed, new firms will be unable to hire the people they need in order to

compete, allowing incumbent firms with high profits to sustain their performance. 2

Therefore, we predict that a competitive labor market increases the rate of profit mean

2
Consistent with this, the endogenous growth literature argues that the most important mechanism by
which labor market competition could affect growth is via the impact on the rates at which low productivity
companies close down and high productivity companies start up (see Barro and Sala-i-Martin 1995 for a
survey).

8
reversion by reducing differences in labor rates and productivity across firms. Mean

reversion of corporate losses will also be faster in countries with more competitive labor

markets. Lower costs of restructuring the employee base and layoffs can enable

companies with poor performance to lower their costs and become competitive. As a

result, the rate of mean reversion of corporate losses will also be greater in countries with

more competitive labor markets.

Competition in the labor market is expected to vary by country because labor laws

heavily influence the employment and compensation contracts of labor forces (Botero et

al. 2004). Rules governing employment security and unemployment legislation vary

systematically across countries, and compensation contracts are greatly influenced by the

bargaining power of domestic labor forces (Freeman 1988, Siegel and Larson 2009).3 In

our empirical tests, we use measures of labor market regulation (e.g., unemployment and

immigration laws) and other qualitative assessments of employment flexibility to gauge

competition in the labor market.

Government efficiency: Government efficiency measures the extent to which a

government effectively promotes competition. The role of the government in promoting

competition is widely debated. Some scholars argue that governments should play a

limited role in regulating competition (Johnson, McMillan, and Woodruff 2002). Others

argue that market imperfections make government regulation essential to the effective

functioning of markets (Frye and Shleifer 1997; Hellman, Jones, and Kaufmann 2003). In

our empirical tests, we assess the efficiency of government using qualitative measures of

government policies’ effectiveness at promoting business activities, and do not attempt to

3
Siegel and Larson (2009) show that the extent to which the pay-for-performance relationship holds in
different countries is related to the bargaining power of domestic labor unions.

9
directly measure the level of government intervention. Examples of these measures are

effective implementation of government decisions, absence of bribery and corruption,

and adaptability of government policies to changes in economic conditions.

III. Research design

We test the effect of institutional characteristics on performance persistence using the

partial adjustment model proposed by Fama and French (2000):

ROEt+1 – ROEt =  +  [ROEt – E(ROEt)] +  [ROEt – ROEt-1] + t+1 (1)

where ROE is operating income4 divided by book value of equity, and E(ROE) is the

predicted ROE from separate regressions for each year, of ROE on dividends over book

value of equity, firm size measured as the natural logarithm of sales, leverage measured

as total debt over total assets, the market-to-book ratio, industry indicator variables, and

country indicator variables (Fama and French 2000; 2006).5 The estimated coefficient 

is the level of mean reversion in profitability and our main variable of interest. The

second term, ROEt – ROEt-1, is included to control for residual autocorrelation in changes

in ROE not captured by the first partial adjustment term.

To examine whether country-level institutional variables affect mean reversion,

we estimate the following variant of model (1):

4
We use operating income because we want to capture the intertemporal dynamics of the ability of a
company to deliver performance from its operations, and because our hypotheses focus on how institutional
characteristics affect a firm’s ability to sustain economic performance. Moreover, using operating income
we avoid introducing noise in the estimates because of differences across countries in the accounting
treatment of non-operating and special items. When we use net income excluding extraordinary items we
find very similar results and when we use net income including extraordinary items we find similar results
but the statistical significance is reduced.
5
The average explanatory power of this model is 23%, similar to the explanatory power that Fama and
French (2000) report in their sample of US firms. We also estimated expected ROE by omitting country
and industry indicator variables. The predicted ROE was highly correlated (0.90) with the estimate we use
in the paper.

10
ROEt+1 – ROEt =  +  κ * COMP/EFF +  [ROEt – E(ROEt)] +  [ROEt – ROEt-1] +

  * [ROEt – E(ROEt)] * COMP/EFF +   * [ROEt – ROEt-1] * COMP/EFF + t+1 (2)

The interaction term  directly tests our main prediction that mean reversion of

corporate profits vary systematically with a country’s product and factor market

competition and government efficiency (COMP/EFF). The estimated coefficients

represent the incremental mean reversion associated with these factors. We cluster

standard errors both at the firm level and at the year level to control for serial correlation

in performance persistence within the same firm, and for cross-firm correlation within the

same year (Petersen 2009).

In addition to the country variables of primary interest, Model (2) includes

interactive firm and industry variables that prior research indicates are related to mean

reversion in profitability. Firm-level variables include market share, R&D intensity, the

market-to-book multiple, accruals, and the level of diversification. Cheng (2005) finds

that market shares explain variation in abnormal earnings. We measure market share as

the ratio of a firm’s sales to total industry sales, where industries are classified using the

Fama-French (1997) four-digit classification. R&D intensity controls for future

profitability and is measured using R&D expense deflated by sales (Cheng 2005). We use

market-to-book to control for future growth opportunities (Nissim and Penman, 2001).

Accrual controls reflect a well-known difference in the persistence of accruals and cash

flows that could affect the mean reversion of profitability (Sloan, 1996). Also, Leuz et al.

(2003) show how accrual levels differ across countries from differences in accounting

policies and management opportunism. Finally, we include a control variable for the level

of industry diversification of the company, because diversified firms have more stable

11
economic performance and as a result they will exhibit a slower mean reversion in

profitability.

Industry-level factors include the industry market-to-book ratio as a proxy for the

growth prospects of the industry. Following Cheng (2005), we control for industry

product innovation using industry R&D intensity, measured as mean R&D to sales ratio

of all firms in the industry. We also include the Herfindahl industry concentration index,

computed by the sum of squared market shares of all firms in an industry, to reflect

industry competition (Lev 1983). Prior research indicates that the index is negatively

related to industry mean reversion.

IV. Sample and Data

Country-Level Competition and Government Efficiency Data

Annual data on country product and factor market competition and government

efficiency are from the IMD World Competitiveness Yearbook (WCY). Since 1996

WCY has analyzed and ranked the ability of nations to create and maintain an

environment that sustains enterprise competitiveness. 6 The yearbook compares the

performance of 58 countries based on more than 300 criteria measuring different facets of

competition. Approximately two thirds of the data come from statistical databases

(international/national sources) and the remaining third from surveys (Executive Opinion

Survey).

The statistical indicators provided by WCY are acquired from international,

national and regional organizations, private institutions and a network of 54 partner

6
For more information, see http://www.imd.org/research/publications/wcy/index.cfm

12
institutes worldwide. The Executive Opinion Survey measures perceptions of

competitiveness by business executives who are dealing with international business

situations. They cover factors that are not easily measurable using output data, such as

management practices, labor relations, corruption, environmental concerns, and quality of

life.

The survey is sent in January to executives in top and middle management

positions in all of the economies covered by the WCY and returned in April. In order to

cover a representative sample, IMD’s sample size is proportional to the GDP of each

economy. The sample of respondents is representative of the entire economy, covering a

cross-section of the business community in each economic sector: primary,

manufacturing, and services, based on their contribution to the GDP of the economy. The

survey respondents are nationals or expatriates located in local and foreign enterprises in

the country who have international operating experience. They are asked to evaluate the

present and expected competitiveness conditions of the economy in which they operate

and have resided during the previous year, drawing from their experience, thereby

ensuring that the evaluations portray an in-depth knowledge of their particular

environment.

All country-level institutional variables, which take a value from 1 to 10, are

defined in the Appendix. The product market competition variable includes measures that

reflect both the openness of the product markets to foreign firms, and policies, laws and

regulations that directly affect the level of competition in the product market. Labor

market competitiveness includes measures for the rigidity of the labor market and

policies and laws that affect the supply of labor. Capital market competition includes

13
measures of the efficiency of banks, stock markets, and other types of financing

intermediaries. Finally, government efficiency represents the extent to which the

government functions effectively, with transparency and timeliness.

To construct country-level variables for product and factor market

competitiveness and for government efficiency, we first standardize each of the WCY

country variables reported in the Appendix in a given year by subtracting its mean and

dividing by its cross-country standard deviation. This effectively forces each variable to

have equal importance when we aggregate the variables. We then calculate the mean of

the standardized country variables to generate an aggregate measure of product, capital

and labor market competition, and government efficiency. Finally, for each of these four

country-level variables, the sample countries are assigned an ordinal ranking, ranging

from one to fifty-eight, reflecting their relative performance. This procedure is consistent

with how the IMD calculates and publishes the rankings of the competitiveness of

nations.

Firm Performance Data

Our data on firm performance are from Worldscope. We restrict our sample for

the years 1997 to 2008. Prior to 1997, WorldScope has data for only a few developing

countries, restricting our ability to investigate the role of country characteristics in

performance mean reversion. From the universe of WorldScope we delete observations

with missing data, negative book value of equity, ROE greater than 100% or less than

-100%, banks and other financial firms, firms with missing data for consecutive years,

firms from countries with no available data in the WCY, and firms from countries with

14
fewer than 50 observations.7 The final sample comprises 260,347 firm-year observations

for 42,337 unique firms from 49 countries.

Table I presents summary statistics of the firm-level variables included in the

empirical tests. For each country, Table I shows the mean and standard deviation of the

change in ROE, market share, R&D, market-to-book multiple (MTB), Herfindal index,

absolute accruals, and the logarithm of the number of business segments. For most

countries, the average change in ROE is negative. The average market share, R&D, and

MTB across countries are 0.20, 1.5%, and 2.12 respectively. The average Herfindal index

is 0.31, mean absolute accruals deflated by assets are 6.1%, and the log of number of

segments is 0.72. In addition, Table I shows that there is substantial variation in the

means of each of these variables across the sample countries.

Table II presents univariate correlations between the independent variables.

Countries with more competitive product, capital and labor markets and higher

government efficiency, have firms with higher R&D, MTB multiples, industry MTB,

absolute accruals, and industry R&D, and firms with lower market shares, Herfindal

indices, and less business diversification. The highest univariate correlation between any

of the competitiveness/government efficiency variables is for product market competition

and government efficiency (0.709), and the lowest correlation is for product and labor

market competition (0.560).

V. Results

Primary Results

7
Most of the observations we eliminate are for firms classified as financial institutions, or firms with
missing observations for some of the variables of interest.

15
Table III presents the results of estimating model (2). 8 Because the country level

variables are highly correlated (see Table II), we examine the significance of each such

variable individually and as a group. Columns (1) to (3) show that all the interactive

coefficients on the country competition variables are negative and significant, implying

that increased product and factor market competitiveness increase the rate of mean

reversion as predicted.9 These effects are economically, as well as statistically significant.

An inter-quartile increase in product market competition, capital market competition, and

labor market competition, increase the mean reversion of profitability by 4.5%, 4.6%, and

3.1% respectively. Column (4) shows that the coefficient on government efficiency is

statistically insignificant.

Column (5) includes all country variables simultaneously in the model. 10 The

interactive product and capital market competition estimates continue to be negative and

significant, implying that increased competition in these markets is accompanied by

higher mean reversion in profitability. In this specification, an inter-quartile increase in

product and capital market competition increases the rate of mean reversion of

profitability by 5.3%, and 4.4% respectively. Interestingly, the estimate for government

efficiency is now positive and significant. An inter-quartile increase in government

efficiency decreases the rate of mean reversion of profitability by 4.3%. One plausible

interpretation of this finding is that more efficient governments lower the risk of

appropriation holding constant product, capital, and labor market competition. For

8 In untabulated analysis we find that the mean reversion for the pooled sample of all countries is
0.31. Fama and French (2000) estimate the mean reversion of US only firms for an earlier period at
0.38.
9 The mean reversion parameters in all these models are negative. A negative interaction term

therefore implies that the rate of mean reversion is greater for more competitive countries.
10
None of the variance inflation factors were higher than four suggesting that multicollinearity is not a
significant problem for this econometric analysis.

16
example, in countries with lower government efficiency corrupt government officials

might ask bribes that are an increasing function of a firm’s profitability.

To further demonstrate how differences in country variables affect firm

performance, we estimate ROE mean reversion for the five countries with the least

competitive product markets (lowest decile) and the five countries with the most

competitive product markets (top decile) throughout the sample years. The estimated

mean reversion for these countries are 0.35 and 0.24 respectively. Figure 1 shows that

firms with extreme positive ROEs of 35% (the top decile) can expect to see their ROE

fall to 10% (5%) within three (five) years if they are domiciled in countries with highly

competitive product markets, versus five (eight) years if they are in the least competitive

markets. Similarly, firms with extreme negative ROEs of -23% (lowest decile) can

anticipate their ROE increasing to -10% (-5%) after three (four) years if they are in the

most competitive product markets versus four (six) years if they are in the least

competitive markets.

To illustrate how these differences affect firm valuation, consider a hypothetical

firm with a normal ROE of 13%, cost of equity of 10%, and book equity growth of 4%.

For such a firm domiciled in countries with the least competitive product markets, an

unexpected increase in ROE to 35% (that subsequently reverts back to the normal 13%)

would generate an increase in its value-to-book multiple of 0.71,11 from 1.50 to 2.21. A

comparable shock to ROE for a firm from countries with the least competitive product

markets (where mean reversion to 13% occurs more slowly) would increase the value-to-

11
This value is computed as the following,

(.35  .13)(1  g) t 1 (1  .24) t
Change in value-to-book  t 1
(1  r) t
, where g is the growth rate and r is the cost of

capital, 4% and 10% respectively.

17
book multiple by 0.52. Therefore, the incremental value of being located in a country

with low product market competition, for a given shock in profitability, is 0.19, in terms

of the value-to-book multiple. Similarly, if this hypothetical firm experienced a shock

that decreased ROE to -23% (with reversion back to the normal 13%), its value-to-book

ratio would fall by 1.16 (from 1.5 to 0.34) if it was domiciled in a country with the least

competitive product markets versus 0.84 if its home country had the most competitive

product markets, where reversion would occur more rapidly.12

As noted above, model (2) also controls for other firm and industry level variables

that have been shown to predict performance mean reversion in prior studies. Consistent

with these earlier findings, the results in Table III indicate that profitability mean

reversion decreases with firm market share, MTB, and diversification. Consistent with

prior literature, we find that mean reversion increases with firm R&D (Cheng 2005),

industry MTB (Nissim and Penman 2001), and the Herfindal index (Jacobsen 1988). For

our sample, mean reversion is positively related to accruals, whereas other US based

studies report a negative relation consistent with accruals being less persistent than cash

flows (Sloan 1996).

Table IV presents results of tests that examine the robustness of our results. The

first two columns test whether home country competitiveness and government efficiency

factors have similar effects on firms that operate primarily in the domestic market and for

firms with extensive multinational operations. Domestic firms are defined as those with

more than 80% of assets and sales in the home country market, whereas multinational

12
Refer to footnote 11 and Healy, Palepu, and Bernard (2000), or Penman (2006) for the mathematical
equations.

18
firms have more than 20% of sales or assets outside their home country. 13 The first

column shows that the results for domestic firms are very similar to those reported in

Table III. Performance mean reversion is lower in countries with more competitive

product and capital markets and in countries with less efficient governments.

The second column shows the results for multinational firms. Home country

competition and government efficiency also affect the performance mean reversion for

these firms, but the effects are expected to be lower than for purely domestic firms since

firms with multinational operations are exposed to other markets. The coefficient

estimate on the capital market competition interaction is consistent with this prediction.

Multinational firms are less affected by the characteristics of local capital markets (-0.027,

p-value=0.429) than purely domestic firms (-0.054, p-value=0.004). One explanation for

this finding is that multinationals rely less on domestic capital markets because they have

greater access to internal financing opportunities (see Desai et al. 2008). The coefficient

on labor market competition interaction is negative and significant for multinational firms

(-0.093, p-value=0.002), suggesting that home country’s labor market characteristics

continue to affect employment contracts in their foreign locations. This can be

understood as MNCs standardizing labor practices across countries in which they operate.

Column three estimates the effect of all institutional variables on performance

persistence, by weighting each observation according to the size of the firm (sales in US

dollars). The results from this estimation, therefore, show how institutional variables

affect performance mean reversion of the larger firms in each economy. We find that for

this specification performance mean reversion is lower in countries with more

13
If either foreign assets or sales are missing, then we define a firm as multinational if either foreign assets
or sales are greater than 20% of total assets or sales respectively.

19
competitive product, capital and labor markets, and in countries with less efficient

government. The overall magnitude of the estimated coefficients is larger than the

coefficients reported in Table III suggesting that the effect of competition on performance

persistence is stronger for larger firms in the economy, perhaps because they are more

visible targets for new entrants.

Finally, in column four we control for the economic development of the country

(GDP per capita). We add this specification to address any concerns that the institutional

effects we have documented simply reflect different degrees of economic development

across countries. After controlling for economic development, we find that performance

mean reversion continues to be higher in countries with more competitive product and

capital markets, and with less efficient government. Interestingly, the relation between

economic development and performance mean reversion is positive and significant,

suggesting that controlling for market competition and government efficiency,

performance in developed economies persists longer than in less developed economies.

This suggests that country-level factors other than those considered in the paper also

affect the mean reversion of profitability.

Alternative estimation strategy

One potential concern about the above findings is that dependencies among the

firm-year observations used to estimate the model have understated our standard errors,

affecting the validity of our inferences. We therefore estimate the model using a country-

year pair as the unit of analysis. This is done by first estimating the  coefficient in model

(1) for each country-year. We then use the estimated  coefficient as a dependent variable

in the following model where the unit of analysis is the country-year:

20
  =  +  COMP/EFF +  Controls (5)

where  is the estimated mean reversion from model (1) for each country-year, and

COMP/EFF are the country competitiveness and government efficiency variables that we

hypothesize determine performance persistence. Controls are the averages of the firm-

level variables that were used as controls in the previous analyses. To reduce noise in the

estimated coefficients, we estimate each regression using weighted least squares where

the weights are equal to the inverse of the standard errors of the estimated mean reversion

for each country-year in model (1).

Table V reports the results, which are quite similar to those reported in Table III,

although, not surprisingly, statistical significance is weaker. In the models where the

country competitiveness/efficiency variables are estimated individually, the estimates for

product and capital market competition are negative and significant at the 10% and 5%

levels respectively. Individual estimates for labor market competition and government

efficiency are insignificant. When all four variables are included simultaneously, the

estimates indicate that more competitive product and capital markets are associated with

faster mean reversion, and higher government efficiency is associated with slower mean

reversion.14 The labor market competition estimate is not statistically reliable. Overall,

we conclude that the results documented in Table III are robust to an estimation strategy

that uses data at the country-year level and as a result has lower statistical power.

Non-linear partial adjustment model

We examine whether country-level factors affect non-linearity in the mean

reversion of profitability. Specifically, we examine how country-level competition has a

14 Again, none of the variance inflation factors were higher than four suggesting that multicollinearity is not
a significant problem for this econometric analysis.

21
differential effect for firms with extreme performance and normal-level of performance,

and 2) for firms with losses and profits. Fama and French (2000) show that extreme

performance show a faster mean reversion than performance further away from the mean.

Although the authors do not attempt to draw formal inferences, they state that this can be

explained by economic forces, i.e., high profit firms facing greater competition from

mimicking firms and extreme loss firms facing greater pressure to divert resources to

more productive uses (pg 171). Also, a long accounting literature shows that accounting

choice driven by managerial incentives can cause an asymmetric response for profits and

losses (Basu 1997). If country level factors have a differential effect on such incentives,

we expect to see country-variation in the asymmetric patterns of profits and losses (Ball

2000).

We estimate a non-linear version of the partial adjustment model in equation (2).

The non-linear terms include a quadratic term for unexpected earnings and an indicator

term for negative profitability. In untabulated results, we find some evidence of faster

mean reversion of extreme profits further away from the average profitability in countries

with higher government efficiency. One explanation for this finding is that efficient

governments are more likely to regulate businesses that have become local monopolies

where as less efficient governments are more likely to be captured by successful local

monopolists. When we consider product, capital, and labor market competition, we find

little evidence of increased competition being associated with faster mean reversion of

extreme than normal level of profitability. Also, we do not find a slower reversal of

profits relative to losses. However, these results should be interpreted with caution

22
because the non-linear specification causes strong collinearity with many of the country

and industry variables included in this study.

VI. Conclusion

This paper tests whether firm performance persistence varies systematically across

countries. We find that country product, capital, and labor market (although the effect of

labor market is not robust across all specifications) competition all affect the rate of mean

reversion of corporate profits. When we consider all variables simultaneously we find

that product market and capital market variables have the largest impact on performance

persistence. Government efficiency increases performance persistence but only when we

control for market competition.

Our findings are likely to be useful to scholars and practitioners interested in

understanding how country factors affect corporate profitability. Further, at a practical

level, our results indicate that valuation exercises, which require terminal value

assumptions on the sustainability of profitability, can benefit from considering country as

well as traditional firm and industry factors in settling on the speed with which superior

or inferior profits are likely to mean revert. More specifically, we show how different

level of performance persistence in each country will affect firm-value through valuation

multiples.

Our study raises several questions for future research. For example, in this paper

we considered home-country characteristics that could affect mean reversion of

profitability across the world. Yet the sustainability of multinational firms’ profitability is

also likely to be influenced by host-country competitive and efficiency factors

(Rodríguez et al. 2005). Future research could also examine whether research analysts

23
understand and incorporate the implications of differences in country product and factor

competition and government efficiency in their long-term forecasts.

24
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 Appendix

Variables from IMD World Competitiveness Yearbook used to Construct Annual

Country Product and Factor Market Competitiveness and Government Efficiency
Variables

Product market competition

Openness
Tariff barriers Tariffs on imports: Most favored nation simple average rate
Customs' authorities Customs' authorities do facilitate the efficient transit of goods
Protectionism Protectionism does not impair the conduct of your business
Public sector contracts Public sector contracts are sufficiently open to foreign bidders
Competition and Regulations
Government subsidies To private and public companies as a percentage of GDP
Subsidies Subsidies do not distort fair competition and economic development
State ownership of enterprises State ownership of enterprises is not a threat to business activities
Competition legislation Competition legislation is efficient in preventing unfair competition
Parallel economy Parallel (black-market) economy does not impair economic development
Ease of doing business Ease of doing business is supported by regulations
Creation of firms Creation of firms is supported by legislation
Start-up days Number of days to start a business
Start-up procedures Number of procedures to start a business
Labor market competition
Labor regulations Labor regulations do not hinder business activities
Unemployment legislation Unemployment legislation provides an incentive to look for work
Immigration laws Immigration laws do not prevent your company from employing foreign labor
Redundancy costs Number of weeks of salary
Labor market flexibility Index on rigidity of employment (index 0-100)
Capital market competition
Bank Efficiency
Banking sector assets Percentage of GDP
Financial cards in circulation Number of cards per capita
Financial card transactions US$ per capita
Investment risk Euromoney country credit-worthiness scale from 0-100
Banking and financial services Banking and financial services do support business activities efficiently
Financial institutions' transparency Financial institutions' transparency is sufficiently implemented
Finance and banking regulation Finance and banking regulation is sufficiently effective
Financial risk factor The risk factor in the financial system is adequately addressed.
Stock Market Efficiency
Stock markets Stock markets provide adequate financing to companies
Stock market capitalization US$ billions
Stock market capitalization Percentage of GDP
Value traded on stock markets US$ per capita
Listed domestic companies Number of listed domestic companies
Stock market index Percentage change on index in national currency
Shareholders' rights Shareholders' rights are sufficiently implemented
Finance Management
Credit Credit is easily available for businesses
Venture capital Venture capital is easily available for businesses
Corporate debt Corporate debt does not restrain the ability of enterprises to compete

29
Government Efficiency
Legal and regulatory framework The legal and regulatory framework encourages the competitiveness of enterprises
Adaptability of government policy Adaptability of government policy to changes in the economy is high
Government decisions Government decisions are effectively implemented
Transparency Transparency of government policy is satisfactory
Bureaucracy Bureaucracy does not hinder business activity
Bribing and corruption Bribing and corruption do not exist

Each sub-variable takes values from 1 to 10. All sub-variables are then standardized across countries by subtracting the average
across the countries and dividing by the standard deviation. Then the standardized values of the sub-variables are aggregated. A
rank variable is then created that provides an ordinal ranking of the countries within each category.

30
Figure I: Evolution of ROE for firms from countries with the least and most competitive product markets

0.40

0.30

0.20

0.10

0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

-0.10

-0.20

-0.30

High Competition Low Competition High Competition Low Competition

Figure I shows the evolution of ROE for two groups of countries: for the five countries with the least competitive product markets and for the five countries with
the most competitive product markets across the years in the sample. The estimated mean reversion for the sample of countries with the most (least) competitive
product markets is 0.35 (0.24). The beginning ROE is equal to the ROE of a firm that ranks on the 90 th percentile or the 10th percentile of the ROE distribution.

31
Table I: Summary statistics by country

ROEt-ROEt-1 Market share R&D MTB Herfindal index Accruals Segments

Country N Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev
Argentina 1,121 0.003 0.215 0.151 0.174 0.000 0.001 1.219 1.579 0.219 0.169 0.049 0.056 0.573 0.646
Australia 6,889 -0.023 0.370 0.061 0.140 0.049 0.193 2.847 3.329 0.224 0.151 0.102 0.149 0.498 0.606
Austria 1,132 -0.014 0.224 0.238 0.251 0.013 0.041 1.814 1.984 0.358 0.206 0.056 0.085 0.981 0.610
Belgium 1,691 -0.003 0.198 0.194 0.258 0.017 0.083 2.254 2.435 0.303 0.226 0.053 0.062 0.863 0.698
Brazil 4,932 0.002 0.285 0.071 0.115 0.001 0.005 1.676 2.600 0.120 0.117 0.038 0.070 0.475 0.760
Canada 9,589 -0.024 0.293 0.048 0.111 0.061 0.202 2.497 2.932 0.158 0.119 0.076 0.102 0.535 0.611
Chile 1,761 0.000 0.150 0.173 0.236 0.000 0.002 1.784 2.315 0.281 0.217 0.047 0.062 0.216 0.513
China Mainland 11,445 -0.013 0.207 0.025 0.062 0.003 0.026 2.947 3.120 0.084 0.086 0.062 0.071 1.062 0.671
Colombia 202 0.003 0.069 0.535 0.377 0.000 0.000 0.900 0.811 0.597 0.315 0.042 0.043 0.115 0.362
Czech Republic 355 -0.018 0.261 0.385 0.389 0.001 0.004 0.887 0.872 0.522 0.320 0.076 0.120 0.751 0.671
Denmark 2,420 -0.017 0.237 0.140 0.173 0.029 0.122 2.270 2.790 0.262 0.165 0.060 0.081 0.771 0.677
Finland 2,445 -0.010 0.180 0.134 0.194 0.022 0.063 2.242 2.359 0.252 0.188 0.056 0.065 1.004 0.691
France 7,710 -0.024 0.268 0.058 0.129 0.022 0.097 2.658 3.028 0.218 0.158 0.052 0.079 0.902 0.623
Germany 8,808 -0.018 0.328 0.048 0.126 0.021 0.084 2.840 3.281 0.177 0.151 0.074 0.108 0.941 0.624
Greece 3,180 -0.027 0.242 0.115 0.191 0.003 0.013 2.721 3.485 0.199 0.182 0.033 0.067 0.455 0.676
Hong Kong 7,255 -0.025 0.263 0.050 0.113 0.008 0.057 1.911 3.108 0.154 0.124 0.078 0.109 0.886 0.573
Hungary 342 -0.009 0.169 0.471 0.336 0.004 0.018 1.298 1.103 0.547 0.276 0.073 0.103 0.836 0.799
India 5,362 -0.016 0.215 0.066 0.142 0.004 0.028 2.597 3.274 0.154 0.149 0.074 0.087 0.810 0.715
Indonesia 3,682 -0.010 0.313 0.090 0.147 0.000 0.005 1.762 2.641 0.171 0.132 0.077 0.085 0.849 0.602
Ireland 699 -0.015 0.264 0.296 0.315 0.034 0.113 3.212 3.601 0.445 0.261 0.057 0.085 0.633 0.535
Israel 1,319 -0.006 0.270 0.219 0.286 0.087 0.178 2.206 2.275 0.402 0.249 0.055 0.069 0.752 0.687
Italy 3,256 -0.019 0.243 0.111 0.168 0.010 0.058 2.187 2.386 0.221 0.144 0.051 0.071 1.211 0.599
Japan 36,675 -0.007 0.169 0.014 0.048 0.013 0.037 1.594 2.068 0.066 0.069 0.036 0.052 1.173 0.509
Jordan 97 0.012 0.112 0.736 0.315 0.001 0.004 2.410 1.207 0.801 0.201 0.060 0.050 0.522 0.674
Korea 7,418 -0.017 0.265 0.054 0.126 0.010 0.038 1.276 1.889 0.214 0.188 0.065 0.076 0.449 0.653
Luxembourg 397 -0.005 0.283 0.381 0.350 0.003 0.014 2.668 3.967 0.482 0.309 0.045 0.056 0.697 0.736
Malaysia 7,098 -0.022 0.221 0.057 0.126 0.001 0.025 1.350 1.924 0.159 0.138 0.064 0.083 0.806 0.641
Mexico 2,616 -0.002 0.149 0.103 0.157 0.000 0.001 1.618 1.789 0.164 0.160 0.048 0.064 0.565 0.653
Netherlands 2,300 -0.020 0.280 0.169 0.246 0.021 0.083 3.135 3.753 0.318 0.215 0.063 0.088 1.004 0.624

32
 ROEt-ROEt-1 Market share R&D MTB Herfindal index Accruals Segments
Country N Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev Mean StDev
New Zealand 918 -0.012 0.258 0.297 0.326 0.023 0.135 2.659 3.423 0.460 0.244 0.072 0.120 0.499 0.604
Norway 1,967 -0.013 0.281 0.151 0.231 0.016 0.085 2.367 2.720 0.304 0.202 0.065 0.085 0.918 0.657
Peru 1,105 0.003 0.219 0.178 0.170 0.001 0.017 2.052 3.368 0.236 0.152 0.077 0.097 0.313 0.565
Philippines 1,848 -0.015 0.233 0.163 0.251 0.002 0.035 1.224 1.910 0.330 0.276 0.059 0.074 0.592 0.635
Poland 1,198 -0.025 0.251 0.212 0.283 0.000 0.003 2.266 2.454 0.350 0.244 0.076 0.086 1.009 0.681
Portugal 778 -0.011 0.245 0.324 0.275 0.000 0.000 2.074 2.603 0.412 0.221 0.056 0.063 0.927 0.716
Qatar 83 0.005 0.093 0.572 0.405 0.000 0.000 2.464 1.830 0.724 0.260 0.058 0.082 0.566 0.659
Russia 682 0.037 0.292 0.143 0.222 0.000 0.002 1.956 2.559 0.225 0.198 0.066 0.104 0.809 0.689
Singapore 4,229 -0.023 0.235 0.095 0.178 0.005 0.039 1.707 2.249 0.254 0.189 0.076 0.093 0.870 0.546
Slovak Republic 93 -0.013 0.379 0.825 0.304 0.003 0.010 0.619 0.569 0.883 0.179 0.056 0.105 0.615 0.720
Slovenia 54 0.003 0.067 0.754 0.333 0.009 0.025 1.709 1.139 0.808 0.235 0.047 0.041 1.119 0.640
South Africa 3,225 -0.018 0.313 0.117 0.185 0.002 0.013 2.382 3.011 0.242 0.174 0.080 0.116 0.672 0.669
Spain 1,664 -0.002 0.185 0.223 0.281 0.004 0.043 2.645 2.958 0.354 0.237 0.024 0.052 0.926 0.676
Sweden 5,632 -0.009 0.295 0.069 0.138 0.048 0.169 2.741 2.907 0.189 0.169 0.071 0.109 0.908 0.677
Switzerland 4,294 -0.007 0.205 0.087 0.138 0.027 0.085 2.371 2.505 0.197 0.128 0.055 0.079 1.002 0.633
Taiwan 8,864 -0.021 0.176 0.038 0.097 0.028 0.064 1.548 1.415 0.115 0.116 0.071 0.082 0.251 0.488
Thailand 6,274 -0.024 0.261 0.060 0.101 0.001 0.025 1.488 1.972 0.136 0.104 0.075 0.080 0.489 0.619
Turkey 1,697 -0.033 0.301 0.184 0.251 0.003 0.008 2.425 3.063 0.324 0.236 0.050 0.087 0.287 0.585
USA 57,578 -0.041 0.353 0.008 0.031 0.081 0.203 3.310 3.978 0.067 0.055 0.084 0.124 0.641 0.612
United Kingdom 15,968 -0.023 0.315 0.029 0.080 0.044 0.162 3.024 3.767 0.136 0.111 0.067 0.093 0.561 0.603

Market share is firm sales over sum of sales of all firms classified in the same Fama-French (1997) industry and country-year. R&D is research and development
expenses over sales. MTB is market value of equity at fiscal year-end over book value of equity. Industry MTB is the average MTB of all firms included in a
Fama-French (1997) industry and country-year. Industry R&D is the average R&D of all firms included in a Fama-French (1997) industry and country-year.
Herfindal is the sum of squared market shares across companies for each industry-country-year. Accruals is the absolute difference between operating income
and operating cash flows, divided by total assets. Segments is the natural logarithm of the number of four-digit SIC codes that the firm operates in.

33
 Table II: Correlation matrix

Product Capital Labor

Market Industry Industry Herfindal
Variable R&D MTB Accruals Segments market market market
share MTB R&D index
competition competition competition
Market share 1.000 -0.068 -0.014 0.075 -0.101 0.646 -0.052 0.075 -0.115 -0.023 -0.121
R&D -0.068 1.000 0.185 0.131 0.532 -0.029 0.170 -0.123 0.127 0.124 0.085
MTB -0.014 0.185 1.000 0.394 0.199 -0.013 0.185 -0.058 0.090 0.124 0.066
Industry MTB 0.075 0.131 0.394 1.000 0.248 0.103 0.046 -0.030 0.095 0.141 0.039
Industry R&D -0.101 0.532 0.199 0.248 1.000 -0.065 0.142 -0.131 0.244 0.247 0.168
Herfindal index 0.646 -0.029 -0.013 0.103 -0.065 1.000 0.009 -0.048 -0.095 0.009 -0.149
Accruals -0.052 0.170 0.185 0.046 0.142 0.009 1.000 -0.116 0.064 0.071 0.053
Segments 0.075 -0.123 -0.058 -0.030 -0.131 -0.048 -0.116 1.000 -0.063 -0.093 -0.060
Product market competition -0.115 0.127 0.090 0.095 0.244 -0.095 0.064 -0.063 1.000 0.622 0.560
Capital market competition -0.023 0.124 0.124 0.141 0.247 0.009 0.071 -0.093 0.622 1.000 0.676
Labor market competition -0.121 0.085 0.066 0.039 0.168 -0.149 0.053 -0.060 0.560 0.676 1.000
Government efficiency -0.055 0.117 0.110 0.155 0.232 -0.038 0.088 -0.072 0.709 0.706 0.619

Table II presents pearson correlation coefficients. Market share is firm sales over sum of sales of all firms classified in the same Fama-French (1997) industry
and country-year. R&D is research and development expenses over sales. MTB is market value of equity at fiscal year-end over book value of equity. Industry
MTB is the average MTB of all firms included in a Fama-French (1997) industry and country-year. Industry R&D is the average R&D of all firms included in a
Fama-French (1997) industry and country-year. Herfindal is the sum of squared market shares across companies for each industry-country-year. Accruals is the
absolute difference between operating income and operating cash flows, divided by total assets. Segments is the natural logarithm of the number of four-digit SIC
codes that the firm operates in. All other variables are defined in the Appendix.

34
 Table III: Relation between performance persistence and competition

(1) (2) (3) (4) (5)

Parameter Estimate p-value Estimate p-value Estimate p-value Estimate p-value Estimate p-value
Intercept 0.0128 0.056 0.0164 <.0001 0.0263 <.0001 0.0118 0.023 0.0174 0.011
(ROEt-Et(ROE)) -0.2844 <.0001 -0.3346 <.0001 -0.3377 <.0001 -0.4369 <.0001 -0.2783 <.0001
(ROEt-Et(ROE))*Market share 0.2620 <.0001 0.2676 <.0001 0.2735 <.0001 0.2701 <.0001 0.2697 <.0001
(ROEt-Et(ROE))*R&D -0.0685 0.003 -0.0683 0.004 -0.0685 0.003 -0.0682 0.004 -0.0696 0.003
(ROEt-Et(ROE))*MTB 0.0150 <.0001 0.0150 <.0001 0.0149 <.0001 0.0148 <.0001 0.0151 <.0001
(ROEt-Et(ROE))*Industry MTB -0.0110 0.005 -0.0108 0.006 -0.0115 0.004 -0.0109 0.006 -0.0117 0.004
(ROEt-Et(ROE))*Industry R&D 0.0081 0.890 0.0131 0.824 0.0024 0.967 -0.0184 0.753 0.0132 0.823
(ROEt-Et(ROE))*Herfindal -0.1106 0.001 -0.1094 0.001 -0.1203 0.000 -0.1054 0.001 -0.1157 0.001
(ROEt-Et(ROE))*Accruals 0.3199 <.0001 0.3175 <.0001 0.3178 <.0001 0.3169 <.0001 0.3157 <.0001
(ROEt-Et(ROE))*Segments 0.0392 <.0001 0.0390 <.0001 0.0391 <.0001 0.0406 <.0001 0.0379 <.0001
(ROEt-Et(ROE))*Product market competition -0.0557 0.000 -0.0657 0.003
(ROEt-Et(ROE))*Capital market competition -0.0423 0.000 -0.0402 0.012
(ROEt-Et(ROE))*Labor market competition -0.0399 0.001 -0.0227 0.152
(ROEt-Et(ROE))*Government efficiency -0.0132 0.349 0.0747 0.001
Firm, industry and country-level controls Yes Yes Yes Yes Yes
Adj R-squared 22.43% 22.42% 22.43% 22.40% 22.47%
N 260,347 260,347 260,347 260,347 260,347

Dependent variable the change in Return on Equity between year t and t+1. The unit of analysis is the firm-year. Market share is firm sales over sum of sales of
all firms classified in the same Fama-French (1997) industry and country-year. R&D is research and development expenses over sales. MTB is market value of
equity at fiscal year-end over book value of equity. Industry MTB is the average MTB of all firms included in a Fama-French (1997) industry and country-year.
Industry R&D is the average R&D of all firms included in a Fama-French (1997) industry and country-year. Herfindal is the sum of squared market shares across
companies for each industry-country-year. Accruals is the absolute difference between operating income and operating cash flows, divided by total assets.
Segments is the natural logarithm of the number of four-digit SIC codes that the firm operates in. All other variables are defined in the Appendix. The lag change
in ROE and all interaction terms between lag change in ROE and other variables are also included but not reported in the table. Standard errors are robust to
heteroscedasticity and clustered at the firm and year level.

35
Table IV: Relation between performance persistence and competition – Robustness tests
Control for
Domestic firms Multinationals Value-weighted economic
development
Parameter Estimate p-value Estimate p-value Estimate p-value Estimate p-value
Intercept 0.0096 0.232 0.0340 0.017 0.0285 0.150 0.0046 0.541
(ROEt-Et(ROE)) -0.3555 <.0001 0.0768 0.558 -0.0561 0.695 -0.2941 <.0001
(ROEt-Et(ROE))*Market share 0.2390 <.0001 0.2870 <.0001 0.2976 0.002 0.2808 <.0001
(ROEt-Et(ROE))*R&D -0.0699 0.007 -0.0232 0.668 -0.2046 0.034 -0.0682 0.004
(ROEt-Et(ROE))*MTB 0.0138 <.0001 0.0185 <.0001 0.0079 0.009 0.0150 <.0001
(ROEt-Et(ROE))*Industry MTB -0.0086 0.064 -0.0237 0.001 -0.0474 <.0001 -0.0120 0.004
(ROEt-Et(ROE))*Industry R&D -0.0851 0.204 0.1745 0.126 0.4116 0.005 -0.0012 0.984
(ROEt-Et(ROE))*Herfindal -0.1296 0.001 -0.0375 0.586 0.1379 0.224 -0.0955 0.005
(ROEt-Et(ROE))*Accruals 0.3034 <.0001 0.4652 <.0001 0.8840 <.0001 0.3103 <.0001
(ROEt-Et(ROE))*Segments 0.0324 <.0001 0.0456 0.001 0.0567 0.004 0.0362 <.0001
(ROEt-Et(ROE))*Product market competition -0.0546 0.028 -0.1057 0.027 -0.1455 0.029 -0.0794 0.000
(ROEt-Et(ROE))*Capital market competition -0.0536 0.004 -0.0266 0.429 -0.0922 0.080 -0.0456 0.008
(ROEt-Et(ROE))*Labor market competition 0.0035 0.852 -0.0928 0.002 -0.0688 0.015 -0.0167 0.328
(ROEt-Et(ROE))*Government efficiency 0.0760 0.003 0.0586 0.176 0.2059 <.0001 0.0614 0.008
(ROEt-Et(ROE))*Economic development 0.0291 0.001
Firm, industry and country-level controls Yes Yes Yes Yes
Adj R-squared 22.15% 24.62% 18.53% 22.54%
N 189,176 71,171 260,347 260,347
Dependent variable the change in Return on Equity between year t and t+1. The unit of analysis is the firm-year. Market share is firm sales over sum of sales of
all firms classified in the same Fama-French (1997) industry and country-year. R&D is research and development expenses over sales. MTB is market value of
equity at fiscal year-end over book value of equity. Industry MTB is the average MTB of all firms included in a Fama-French (1997) industry and country-year.
Industry R&D is the average R&D of all firms included in a Fama-French (1997) industry and country-year. Herfindal is the sum of squared market shares across
companies for each industry-country-year. Accruals is the absolute difference between operating income and operating cash flows, divided by total assets.
Segments is the natural logarithm of the number of four-digit SIC codes that the firm operates in. All other variables are defined in the Appendix. The lag change
in ROE and all interaction terms between lag change in ROE and other variables are also included but not reported in the table. Standard errors are robust to
heteroscedasticity and clustered at the firm and year level.

36
Table V: Relation between performance persistence and competition – Country-year level analysis

(1) (2) (3) (4) (5)

Parameter Estimate p-value Estimate p-value Estimate p-value Estimate p-value Estimate p-value
Intercept -0.1876 0.134 -0.2317 0.001 -0.2573 0.001 -0.3966 <.0001 -0.2202 0.047
Product market competition -0.0461 0.096 -0.0857 0.035
Capital market competition -0.0333 0.025 -0.0613 0.016
Labor market competition -0.0208 0.220 -0.0105 0.686
Government efficiency 0.0220 0.444 0.1310 0.001
Market share 0.2525 0.003 0.2671 0.001 0.2424 0.004 0.2522 0.003 0.2494 0.003
R&D 1.7946 <.0001 1.7917 <.0001 1.6552 <.0001 1.4533 0.000 1.8401 <.0001
MTB -0.0102 0.352 -0.0085 0.433 -0.0112 0.302 -0.0119 0.268 -0.0077 0.474
Accruals 0.1525 0.756 0.0737 0.883 0.1006 0.839 0.1052 0.836 -0.1491 0.758
Segments 0.0200 0.493 0.0183 0.534 0.0153 0.601 0.0179 0.547 0.0141 0.620
Adj R-squared 11.74% 11.96% 11.39% 11.23% 15.06%
N 534 534 534 534 534

Dependent variable is the estimated coefficient  of model (1) from regressions estimated separately for each country-year. The unit of analysis in this table is the
country-year. Market share is firm sales over sum of sales of all firms classified in the same Fama-French (1997) industry and averaged at the country-year level.
R&D is research and development expenses over sales averaged at the country-year level. MTB is market value of equity at fiscal year-end over book value of
equity averaged at the country-year level. Accruals is the absolute difference between operating income and operating cash flows, divided by total assets,
averaged at the country-year level. Segments is the natural logarithm of the number of four-digit SIC codes that the firm operates in, averaged at the country-year
level. All other variables are defined in the Appendix. Standard errors are robust to heteroscedasticity and clustered at the country level.

37