Real And Financial Industry Booms And Busts

The authors examine how product market competition affects firm cash flows and stock returns in industry booms and busts. In competitive industries, they find that high industry-level stock-market valuation, investment and new financing are followed by sharply lower operating cash flows and abnormal stock returns. They also find that analyst estimates are positively biased and returns comove more when industry valuations are high in competitive industries. In concentrated industries these relations are weak and generally insignificant. The results suggest that when industry stock-market valuations are high, firms and investors in competitive industries do not fully internalize the negative externality of industry competition on cash flows and stock returns.