Industry Concentration and Average Stock Returns∗

Kewei Hou David T. Robinson

Fisher College of Business Fuqua School of Business
The Ohio State University Duke University

This Draft: February 15, 2005

ABSTRACT

Firms in more concentrated industries earn lower returns, even after controlling for
size, book-to-market, momentum, and other return determinants. Explanations based on
chance, measurement error, capital structure, and persistent, in-sample, cash flow shocks
do not explain this finding. Drawing on work in industrial organization, we posit that
either barriers to entry in highly concentrated industries insulate firms from undiversi-
fiable distress risk, or that firms in highly concentrated industries are less risky because
they engage in less innovation, thus commanding lower expected returns. Additional tests
support these risk-based interpretations.

JEL Classification Codes: G12, G33, L10

∗ We thank Alon Brav, Anne-Marie Knott, Robert Stambaugh, seminar participants at Ohio State, Arizona,
George Mason, and an anonymous referee for many helpful comments. This paper is a significantly revised
version of a paper entitled, “Market Structure, Firm Size, and Expected Stock Returns.” Judith Chevalier, Eu-
gene Fama, Peter Hecht, Owen Lamont, Toby Moskowitz, Per Olsson, Per Strömberg, and seminar participants
at Chicago and the Chicago Quantitative Alliance provided many helpful comments on this earlier draft. Any
remaining errors are our own.
Correspondence to: Kewei Hou, Fisher College of Business, Ohio State University, 2100 Neil Avenue,
Columbus, OH 43210. E-mail: hou.28@osu.edu.
 Industry Concentration and Average Stock Returns

ABSTRACT: Firms in more concentrated industries earn lower returns, even after controlling
for size, book-to-market, momentum, and other return determinants. Explanations based on
chance, measurement error, capital structure, and persistent, in-sample, cash flow shocks do
not explain this finding. Drawing on work in industrial organization, we posit that either
barriers to entry in highly concentrated industries insulate firms from undiversifiable distress
risk, or that firms in highly concentrated industries are less risky because they engage in less
innovation, thus commanding lower expected returns. Additional tests support these risk-
based interpretations.
 Firms generate cash flows through their actions in product markets. These risky cash flows
are in turn priced in financial markets. Yet, the economic link between product markets and
asset prices remains relatively unexplored. This paper explores the link between industry con-
centration and average stock returns, offering the first empirical evidence of the asset pricing
implications of industry market structure.

A priori, there are a number of potential reasons why the structure of product markets may
affect stock returns. In general, firms take operating decisions that may affect the riskiness of
their cash flows. These operating decisions arise from an equilibrium in the product market
which potentially reflects strategic interactions between market participants. Therefore, the
structure of product markets may affect the risk of a firms’ cash flows, and hence its equilib-
rium rates of return.

Take, for example, innovation. According to Schumpeter (1912), innovation is a form of

creative destruction, and is more likely to occur in competitive industries, or on the fringes of
established industries. If innovation risk is priced, then this predicts that competitive indus-
tries, or firms on the competitive fringe of established industries, earn higher returns, all else
equal. This is one channel whereby the behavior of product market participants, influenced by
the structure of the markets in which they operate, has implications for stock returns.

Or consider distress risk. If barriers to entry in product markets insulate some firms from
aggregate demand shocks, while exposing others, then we would expect to see distress risk
vary with market structure. This predicts that industries with high barriers to entry would be
associated with lower equilibrium stock returns.

Regardless of whether the link between market structure and stock returns is better charac-
terized by distress risk, innovation risk, or through some other channel, our message is simple.
It is well understood from industrial organization that the structure of product markets affects
the equilibrium operating decisions that managers take. If these operating decisions affect the
risk of a firm’s cash flows, then these decisions should impact stock returns.

1
 The main finding in this paper is that firms in highly concentrated industries earn lower
returns, even after controlling for size, book-to-market, momentum, and other known return
predictors. This is true both of industry portfolio returns as well as individual firm-level re-
turns, and it is robust to alternative empirical specifications. Moreover, the economic magni-
tude of these effects is large. Our results indicate that firms in the quintile of most competitive
industries earn annual returns that are nearly four percent higher than those of similar firms in
the quintile of most concentrated industries. This difference is highly statistically significant.

To rule out chance or spurious correlation as a potential explanation for these findings, we
explore a wide range of robustness tests and alternative explanations. Using the Davis, Fama,
and French (2000) files, we extend our main results back to 1927. In addition, the results hold
across a wide range of industry concentration measures. Our sample selection criteria ensure
that the results are not driven by regulated industries, nor are they driven by the de-listing bias
documented by Shumway (1996).

Another possible explanation is that we are simply documenting differences in unexpected

returns that arise from persistent, in-sample cash flow shocks: these shocks may be correlated
with industry concentration in-sample, but are unlikely to persist in the future. To control
for this explanation, we examine the relation between concentration, profitability, and returns.
Our analysis shows that highly concentrated industries have, on average, experienced positive
abnormal profitability, while abnormal profitability for competitive industries has been nega-
tive. Thus, not only does unexpected profitability fail to account for our findings, it works in
the opposite direction. This suggests that we may be understating the true relation between
concentration and expected returns.

Since this is the first paper to demonstrate a role for industry concentration to affect the
cross-section of stock returns, and given that our findings cannot easily be dismissed as arising
from chance, spurious correlation, persistent in-sample cash flow shocks, or correlation with
other known determinants of returns, our next step is to explore the implications of risk-based
explanations for our findings.

2
 We study the time-series properties of the concentration premium to explore its relation
to risk-based explanations such as distress or innovation risk. Spanning tests of the cross-
sectional concentration premium reveal that it is statistically and economically significant and
not well explained by existing asset-pricing factors. Moreover, the concentration premium
exhibits sensible business cycle variation and is related to future real activities. The premium
grows as the economy contracts; it is high when current and near-term GDP growth are low.
This indicates that when future economic conditions look bleak, investors raise required rate
of return for firms in competitive industries.

Finally, our concentration premium largely subsumes the size factor and the market factor,
but the premium on book-to-market grows when we control for concentration. This leads us to
examine the book-to-market spread in returns across concentration quintiles. We show that the
premium associated with the book-to-market ratio is larger in more concentrated industries.
Through double-sort portfolios, we find that most of the spread in returns across concentration
quintiles occurs for low book-to-market firms. This finding supports a risk-based explanation,
since it shows that returns are high for low book-to-market firms in competitive industries
(where book-to-market is low because expected growth is high), while returns are low for
low book-to-market firms in concentrated industries (where book-to-market is low because
capitalized future profitability is high).

Taken together, these findings lean towards the idea that industry concentration proxies for
a risk factor sensitivity. Our findings are consistent with the view that innovation/distress risk,
which is more pronounced in competitive industries, is a priced source of risk in the context
of multifactor asset-pricing models of Merton (1973) and Ross (1976).

This paper is part of a larger literature that links industrial organization to issues in financial
economics. Earlier work such as Titman (1984) studies how capital structure and product
markets interact through the liquidation decision. A number of recent papers have examined
the link between capital structure and industry characteristics; see, for example, Mackay and
Phillips (2002) or Almazan and Molino (2001). In addition, a series of papers, including

3
Asness and Stevens (1996), Moskowitz and Grinblatt (1999), Cohen, Polk, and Vuolteenaho
(2003), and Hou (2003) have demonstrated that a wide range of asset pricing phenomena have
important industry components. To our knowledge, ours is the first paper to link expected
stock returns to industry product-market characteristics through the channel we propose.

The remainder of the paper is structured as follows. Section I motivates our hypotheses
linking industry concentration to stock returns. Section II describes the data and how we con-
struct industry concentration measures. In addition, this section illustrates the relation between
industry concentration and industry-level characteristics. Section III examines how industry
concentration affects the cross-section of stock returns. Section IV examines profitability
surprises as a potential explanation for our results, while Section V presents the time-series
evidence. We explore the relation between value, growth, and concentration in Section VI.
Section VII concludes.

I. The Link Between Market Structure and Stock Returns

For market structure to affect equilibrium stock returns through a risk-based channel, it must
be that equilibrium operating decisions induced by a particular market structure are related to
expected returns. That is, the structure of a product market must affect the risk of a firm’s cash
flows. While it is well understood that market structure affects equilibrium firm behavior, the
literature in industrial organization stops short of making predictions for stock returns based
on this. Our purpose in this section is to conjecture a possible mechanism by which industrial
organization affects equilibrium stock returns.

Of course, whether or not existing asset pricing factors capture the risks brought about by
market structure is an empirical question—one that we address later in this paper. Our goal
in this section is not to argue whether a certain set of priced factors is the correct number for
explaining stock returns, and thus whether existing asset pricing factors should or should not
capture the risks associated with market structure (for more on this see Fama (1998)). Rather,

4
our purpose here is to close the gap between industrial organization and asset pricing by gen-
erating testable predictions for stock returns based on theories from industrial organization.

We focus on two channels through which industry concentration could potentially affect
stock returns. The first draws on Schumpeter’s (1912) concept of creative destruction. The
second, closely related, channel is through barriers to entry.

Creative destruction is the idea that innovation occurs in small firms on the fringes of estab-
lished industries, and that these small challengers ultimately overturn the existing status quo
and usher in a new paradigm. Thus, innovation and technological progress involves unseating
incumbent firms in industries.1

This view has received recent support in industrial organization. Knott and Posen (2003)
show empirically that innovation is increasing in the degree of industry competition. He,
Mørck, and Yeung (2003) present complementary evidence relating turnover in firm domi-
nance to differences in economic growth across countries. They find that economic growth
correlates positively with firm turnover, suggesting that creative destruction is an important
element of long-run growth.

If creative destruction describes the relation between market structure and risky innovative
activities, then this predicts that more concentrated industries have lower average returns, all
else equal, because they engage in less innovation. We can label this the Creative Destruction
hypothesis for stock returns.

An alternative, but related, way to link market structure to stock returns is based on an old
and influential paradigm in industrial organization known as the Structure/Conduct/Performance
1 Schumpeter is associated with two influential views of the link between market structure and innovation.

These two views are at odds with one another. His later view, discussed in Schumpeter (1942), argues that
monopolistic firms have stronger incentives to innovate than firms in competitive industries, since monopolistic
firms can realize the economic profits arising from their innovation, rather than have their super-normal profits
competed away. This later view has received criticism: work by Geroski (1990) finds evidence against the
hypothesis that competitive rivalry diminishes innovation, while Reinganum (1985) models an industry with a
single incumbent and multiple challengers and shows that the challengers have stronger innovation incentives,
suggesting that the level of innovation varies non-monotonically with the number of firms in the industry.

5
(S/C/P) paradigm. This work originated with Bain (1954), who linked the exogenous produc-
tion characteristics of an industry to firms’ pricing behavior, which in turn determined firm
performance.

The observational starting point for the S/C/P paradigm is the nature of the production
technology in an industry, which is taken to be exogenous. For example, the computer chip
manufacturing industry has high fixed costs, since large, expensive plants must be built and
customized to each new chip that is designed. The S/C/P paradigm would view this high
fixed costs as a natural barrier that restricted competitive entry (structure). Since entry to this
industry would be limited, the number of incumbent firms would be few, and each would be
able to price significantly above marginal cost without fear of arousing entry (conduct). As a
result, firms in this industry would earn super-normal economic profits (performance).

The S/C/P paradigm suggests that barriers to entry will affect expected returns whenever
differences in the number of competitors in an industry, or in the pricing practices they ob-
serve, change the risk characteristics of firms in question. For example, barriers to entry may
affect how firms optimally respond to aggregate demand shocks. Firms in high barriers to
entry industries can respond to positive demand shocks by increasing prices or raising output
without fearing competitive entry. All else equal, this raises their expected future profitability,
giving them deeper pockets that help them to weather downturns without facing industry exit.
Thus, if exit in response to aggregate demand shocks is associated with priced distress risk,
we would expect these firms to face less distress risk.2

Looking across industries, we would expect firms in high barriers to entry industries to earn
lower average returns since the average distress risk would be lower in these industries. To
test this prediction, one empirical approach would be to measure barriers to entry directly and
relate them with stock returns. However, recent work in industrial organization has focused
2 Industry exit could potentially be priced if it changed the production possibilities of the economy and hence

the investment opportunity set faced by investors; this would be the case if, for example, it involves abandoning
investments that are costly to reverse, or redeploying assets and human capital to production processes for which
they were not originally specialized.

6
on the fact that barriers to entry reflect the strategic choices of incumbent firms in addition to
the inherent production characteristics of the industry. This is illustrated in a large body of
work including Schmalensee (1978), Salop (1979), Schmalensee (1981), Sutton (1991), and
Sutton (1998). The fact that barriers to entry reflect strategic choices of incumbent firms as
well as the primitives of industry production technology makes it impractical to link stock
returns directly to barriers to entry. In particular, the strategic nature of barriers to entry not
only makes them difficult to measure, but introduces potential endogeneity with stock returns.
For a variety of reasons, direct measures of barriers to entry are unattractive or incomplete.

Instead, we focus on industry concentration as a measure of barriers to entry, since it is a

natural consequence of barriers to entry, regardless of the manner in which they came to be.
Under the barriers to entry hypothesis, we hypothesize that firms in highly concentrated indus-
tries earn lower returns because, all else equal, they are better insulated from undiversifiable,
aggregate demand shocks.

II. Data and Measures of Industry Concentration

A. Sample Selection

Our sample includes all NYSE/AMEX/NASDAQ listed securities with sharecodes 10 or 11

(e.g., excluding ADR’s, closed-end funds, REIT’s) that are contained in the intersection of the
CRSP monthly returns file and the COMPUSTAT industrial annual file between July, 1963 and
December, 2001. Prior to January, 1973, industry coverage is more sparse, since the CRSP
sample includes NYSE and AMEX firms only. However, all of our findings hold on the 63-01
sample period as well as the 73-01 sample period. Throughout our analysis, we employ the
corrections suggested in Shumway (1997) for the de-listing bias, but these adjustments have
no effect on our results.

7
 To ensure that accounting information is already impounded into stock prices, we match
CRSP stock return data from July of year t to June of year t +1 with accounting information for
fiscal year ending in year t −1 as in Fama and French (1992). To be included in our return tests,
a firm must have CRSP stock price, shares outstanding and 3-digit SIC classification for June
of year t.3 Some of our tests require the presence of COMPUSTAT data on earnings, sales,
book equity, market equity and total assets for fiscal year t −1. This data requirement probably
biases our sample towards larger firms, which may in turn diminish the overall variation in the
concentration measures.

Book equity is stockholder’s equity (or common equity plus preferred stock par value, or
asset minus liabilities) plus balance sheet deferred taxes and investment tax credit minus the
book value of preferred stock and post retirement asset. COMPUSTAT market equity is stock
price times shares outstanding at fiscal year end. The book-to-market ratio is calculated by
dividing book equity by COMPUSTAT market equity. Earnings is earnings before interest,
which is income before extraordinary items plus interest expense plus income statement de-
ferred tax. Leverage is defined as the ratio of book liabilities (total assets minus book equity)
to total market value of firm (COMPUSTAT market equity plus total assets minus book eq-
uity). Size (CRSP market equity) is measured by multiplying shares outstanding by stock
price for June of year t. We follow Fama and French (1992) to estimate market β by comput-
ing full-period βs for portfolios sorted by size and pre-ranking β and then assigning portfolios
βs to stocks in those portfolios. The pre-ranking β is estimated as the sum of the coefficients
of regressions of individual monthly stock returns on contemporaneous and lagged market
returns over the past three years.

Throughout the paper, we use three-digit SIC classifications to define industry member-
ship. This choice balances two offsetting concerns. On the one hand, we wish to use fine-
grained industry classifications so that firms in unrelated lines of business are not grouped
3 Kahle and Walkling (1996) report problems between CRSP and COMPUSTAT with regard to SIC industry
classifications. To minimize any impact this may have on our results, and to maintain internal consistency with
our variable construction, we disregard COMPUSTAT SIC classifications.

8
together. On the other hand, using too fine an industry classification results in portfolios that
are statistically unreliable and firms being grouped into distinct industries arbitrarily. Choos-
ing 3-digit classifications strikes a balance between these two concerns. Although all of the
results in the paper are presented with 3-digit SIC classifications, in unreported tables we have
replicated our findings at the 2- and 4- digit level.

Finally, we remove regulated industries from our sample.4 Regulated industries may face
lower costs of capital either because they have lower operating risks (due to regulated entry
and exit), or because their capital structure and/or capital charges are regulated. If regulation is
correlated with industry concentration, then this could potentially explain our findings without
offering any fresh insights into the structure of asset prices. In addition, regulation may cause
some of the financial ratios we employ to behave unusually. Removing these industries has no
material effect on our findings.

B. Measuring Industry Concentration

We measure industry concentration using the Herfindahl index, which is defined as follows:

I
Herfindahl j = ∑ s2i j , (1)
i=1

where si j is the market share of firm i in industry j. We perform the above calculations each
year for each industry, and then average the values over the past three years. This ensures that
potential data errors do not have undue influence on our Herfindahl measure.5

The Herfindahl measure uses the entire distribution of industry market share information
to obtain a complete picture of industry concentration. Small values of the Herfindahl index
4 The industries are taken from Barclay and Smith (1995).
5 In unreported robustness tests, we have varied the averaging horizon of the Herfindahl calculation from one
year (i.e., no averaging) to ten years. We have also skipped multiple years between the Herfindahl calculation
and the returns, and we have related Herfindahl in the beginning of the sample to late-sample returns. These
robustness checks ensure that our results are not affected by industries with large swings in Herfindahl. Our
findings go through under all of these alternative specifications.

9
imply that the market is shared by many competing firms, while large values imply that market
share is concentrated in the hands of a few, large firms.

The standard way of measuring Herfindahl is to use net sales to calculate market share. We
call this variable H(Sales) in our analysis. We also compute H(Assets) and H(Equity) mea-
sures using total assets and book equity, respectively, to compute market share. The H(Equity)
measure allows us to use Davis, Fama, and French (2000) data and extend our results back to
time periods before net sales and asset data are widely available through COMPUSTAT. The
measures are only imperfectly correlated with true market share, but to ensure that they pro-
duce reasonable values, we compare the three measures on the 1963-2001 time frame during
which all three measures are available. As Panel A of Table I shows, they are highly correlated.

It is important to point out that our use of the Herfindahl index differs from prior applica-
tions in corporate finance. In particular, many papers studying the diversification discount use
a within-firm, rather than within-industry, Herfindahl index to measure the degree to which
internal investment opportunities of a single firm are spread across many projects (diversified
firms) or only a few projects (focused firms). For example, see Berger and Ofek (1995), Ra-
jan, Servaes, and Zingales (2000) or many others. Instead, our measure captures market shares
across all firms in a given 3-digit industry.

C. Characteristics of Concentration Sorted Portfolios

In Panel B, we report characteristics averaged across concentration quintiles. The spread

in H(Sales) is large: the most competitive quintile has an average H(Sales) of .133, while
the most concentrated quintile has an average of .982. In addition, the production, risk, and
profitability characteristics of the industry quintiles tell us much about the nature of industry
concentration.

Average sales and assets are significantly larger for the most concentrated quintiles, but
size is smaller for the most concentrated quintile. (This seemingly contradictory result reflects

10
skewness in the size distribution of firms within an industry.) The number of new listings and
the number of de-listings is significantly higher in the quintile of most competitive industries,
which suggests that barriers to entry are higher in more concentrated industries.

Measures of risk and leverage are largely flat across concentration quintiles. The average
book-to-market ratio is roughly constant, as is the average β. Leverage is roughly flat across
the quintiles as well.

Unlike risk and leverage, profitability shows considerable variation across quintiles. We
summarize profitability with four measures. Earnings to assets (E/A in Table I) averages 1.3%
for the lowest concentration quintile, jumps to 2.9% for the second lowest quintile, and is
above 3% for the remaining three quintiles. Similarly, earnings to sales (E/S) ranges from
11% for the lowest concentration quintile to 13.6% for the highest concentration quintile.
More concentrated industries have higher profitability on average; this is consistent with the
view that industry concentration is an indirect measure of barriers to entry.

The variable labelled ‘V/A’ is our proxy for Q: this is simply market value of assets over
book value of assets. It exhibits similar behavior, ranging from 1.29 for the lowest concentra-
tion quintile to 1.70 for the highest concentration quintile. The positive correlation between
Q and industry concentration suggests that firms high industry concentration not only have
higher current profitability, but that this profitability is expected to persist in the future.

The dividend payout ratio (D/B in Table I) also increases with industry concentration.
Since Fama and French (2000) and many others have related dividend policy to expected
profitability, we take this as further evidence that firms in high concentration industries are
more profitable. We take this issue up in further detail in Section IV.

To get a sense of how Schumpeter’s prediction squares with our data, we also report two
measures of R&D intensiveness. The first is simple the R&D value reported on Compus-
tat. The gross level of R&D declines substantially as concentration increases, falling from an
average of $35M per firm-year for the least concentrated quintile to $13M for the highest con-

11
centration quintile. When we scale by total assets, we see the same pattern: the R&D to asset
ratio falls from 7.5% for the lowest concentration quintile to 2.7% for the most concentrated
quintile.

In Table II, we report Fama and MacBeth (1973, henceforth FM) regressions of the cross-
section of industry concentration measures on industry average characteristics. We estimate
equations of the following form:

N
H(Sales) jt = αt + ∑ λnt X jt + ε jt (2)
n=1

where the X jt are industry average characteristics. Regressions are run for every year t from
1963 to 2001, and the time-series means of annual cross-sectional coefficient estimates are
reported along with the time-series t-statistics. This procedure allows for multivariate corre-
lation analysis, and it is robust to cross-correlated error terms. The resulting coefficients can
then be interpreted as simple or conditional correlations between concentration and industry-
average characteristics, and appropriate statistical inferences can be drawn about the magni-
tude of these relations.

The row described as ‘simple’ reports results from FM regressions of concentration on

each characteristic in isolation. (Thus, there are eleven separate univariate regressions reported
in a single row.) Each row under the panel labelled ‘Multiple’ reports a single regression in
which multiple characteristics are included as independent variables simultaneously. This
provides conditional correlations of H(Sales) on industry characteristics.

The FM regressions provide an econometrically sound way to corroborate the average

characteristics reported in Table I. When we combine the correlations reported here with the
descriptive statistics from Table I, a picture of industry concentration emerges that is con-
sistent with the prior literature discussed in Section I and important for the interpretation of
our findings. Measures of profitability are positively correlated with industry concentration.
Earnings to assets, earnings to sales, and market to book ratios are all highly positively cor-

12
related with industry concentration, both unconditionally, and conditional on other industry
characteristics.

Concentrated industries have large asset bases and high unit profitability. In addition,
R&D/Assets is much lower for highly concentrated industries. Thus, highly concentrated
industries have high capitalized future profitability but do not engage in risky innovation (they
do not have high levels of R&D). These descriptive statistics paint a picture of concentrated
industries as innovation-poor, profit-rich industries with high barriers to entry.

III. Concentration and the Cross-Section of Returns

A. The Concentration Spread

Table III relates industry concentration to the cross-section of average stock returns, measured
both at the industry and firm level. In June of each year, industries are sorted into quintiles
based on their Herfindahl index. We then report average monthly returns and t-statistics for
these portfolios, as well as the difference between Quintile 5 (most concentrated) and 1 (least
concentrated).

The first row in the left panel presents raw average returns computed by equally weighting
firms within each concentration portfolio. Looking across Herfindahl quintiles, firms in the
least concentrated (most competitive) industries earn an average return of 1.52% per month.
This declines to 1.26% per month for firms in the most concentrated quintile. The spread
between the two is -0.26% per month, which carries a statistically significant t-statistic of
2.14.

Concentration is an attribute of an industry, not a firm, so there is flexibility in how quintile

returns are measured. The right panel reports returns calculated by first forming industry port-
folios, and then equally weighting industry returns within each concentration quintile. These

13
industry-level returns mirror the firm-level results. In each case, we see a large and statistically
significant spread between the most concentrated and the most competitive quintile.

Since Table I shows that industry concentration is associated with a number of known
determinants of average returns, we also report characteristics-adjusted returns. We use the
procedure in Daniel, Grinblatt, Titman, and Wermers (1997) to adjust individual stock returns
for size, book-to-market, and momentum. All firms in our sample are first sorted each month
into size (CRSP market capitalization) quintiles, and then within each size quintile, further
sorted into book-to-market quintiles. Within each of these 25 portfolios, firms are again sorted
into quintiles based on the firm’s past 12-month return, skipping the most recent month. Stocks
are averaged within each of these 125 portfolios to form a benchmark that is subtracted from
each individual stock’s return. The expected value of this excess return is zero if size, book-
to-market and past one-year return completely describe the cross-section of expected returns.

The characteristic-adjusted average returns of the above quintile portfolios as well as the
average spread between Quintile 5 and 1 are reported in the second row of each panel. Even af-
ter adjusting for these characteristics, we still see a significant spread in average returns across
concentration quintiles. Interestingly, adjusted returns for the quintile of the most competi-
tive industries (Q1) are positive and statistically significant, and they decrease monotonically
to negative and statistically significant for the quintile of most concentrated industries (Q5).
However, the adjustments only serve to increase the spread in returns. The spread for Herfind-
ahl index jumps to -0.36% per month, ten basis points higher in absolute value than the raw
returns figure. Likewise, the spread for industry portfolios grows two basis points to -28 basis
points. Together, this suggests that the return premium associated with industry concentration
is independent from those of size, book-to-market and momentum, and that controlling for
industry concentration is important for understanding the cross-section of stock returns.

In the second set of numbers, we take a number of steps to control for a variety of potential
explanations for our result. We extend our results back to 1927 by using an H(Equity) concen-
tration measure constructed from the Davis/Fama/French files. The row reporting results from

14
1951-2001 uses the entire length of the Compustat sample to compute Herfindahl indices, in
spite of the fact that the data only contain NYSE-listed firms until 1963. Data from 1974-2001
show our results over the sub-sample for which we have Nasdaq, AMEX, and NYSE stocks.
The concentration spread is robust to each of these specification choices.

The third set of numbers pushes the robustness question further with results from quin-
tiles formed on alternative concentration measures.6 The concentration premium is robust to
using H(Assets) or H(Equity) to form concentration quintiles. The concentration premium
also shows up significantly when we use net sales from the Compustat Business Segment file
(available 1985-2001) to attribute sales of conglomerate firms to their respective industries.

B. Fama-MacBeth Cross-Sectional Regressions

To further examine the relation between industry concentration and average stock returns, we
conduct FM regressions of monthly stock returns on industry concentration and other charac-
teristics. In Panel A of Table IV, we report regressions of industry portfolio returns regressed
on industry characteristics and the H(Sales) measure. The time series average of each cross-
sectional regression loadings is reported along with its time-series t-statistic. These regression
coefficients can be interpreted as returns to zero-cost portfolios with the weighted characteris-
tic equal to one on the corresponding regressor and zero on all other regressors (Fama 1976).
These regressions provide robustness check of the relationship between industry concentra-
tion and average returns without imposing quintile breakpoints and allow us to control for
additional alternative explanations.

The first column of Panel A shows that more concentrated industries earn lower average
returns, consistent with our previous results from quintile portfolios. The cross-sectional re-
gression coefficient on the H(Sales) index is negative and statistically significant at the 5%
6 In tables available from the authors, we have also replicated our findings on the much smaller sample of
observations for which Census of Manufactures definitions of industry concentration are available. In addition,
we have repeated our findings using the ratio of the sales of the top five firms in an industry to total industry sales
(the 5-firm ratio).

15
level. The next seven rows demonstrate that industry average returns are positively related to
industry average book-to-market ratio, leverage and momentum (past one year’s industry re-
turn), negatively associated with industry average size, and insignificantly related to industry
average market β.

The fourth and the last rows re-examine the industry concentration effect, but control for
the above characteristics. These rows show that controlling for these variables does not drive
out the significance of the industry concentration effect. By including leverage in our re-
gressions, we control for another possible explanation for our findings, which is that highly
competitive industries have high leverage, thus raising the required return on equity through
a Modigliani and Miller (1958) effect. In the univariate FM regression, leverage works in the
predicted direction, but controlling for other characteristics drives out leverage.

Thus, while the results of Table I suggest that industry concentration is correlated with
other industry characteristics that describe average returns, the results from the top of Table
IV suggest that those correlations are not the driving forces behind the inverse relationship
between industry concentration and average stock returns.

Panel B of Table IV repeats the analysis described above, but replaces industry portfo-
lio returns with firm-level stock returns, and replaces industry characteristics with firm-level
measures of size, book-to-market, leverage, and market β. These results mirror those obtained
from industry portfolio regressions. FM regressions of individual stock returns on Herfind-
ahl index alone produce an average slope coefficient of -0.35% with a t-statistic of -2.41.
Accounting for the premia associated with known return predictors strengthens these results.
Introducing size, book-to-market ratio, past one year return, leverage and market β to the
cross-sectional regressions raise both the point estimates as well as the t-statistics for industry
concentration.

The conclusion that emerges from this section is that not only do industry returns vary
with industry concentration, but individual stock returns do as well: firms in concentrated
industries earn lower stock returns than firms in more competitive industries. The results hold

16
under a variety of different empirical strategies, and are robust to whether or not we control
for characteristics such as size, book-to-market, and past returns, both at the firm and industry
levels. These controls suggest that the industry concentration effect we have identified are not
being driven by correlations with other determinants of expected returns, or through capital
structure choice.

IV. Industry Concentration and Profitability Surprises

The preceding section has demonstrated a statistically reliable and economically meaningful
link between market structure and average stock returns. However, we know from the work
of Campbell (1991), Campbell and Shiller (1988), Campbell and Vuolteenaho (2003), and
Vuolteenaho (2002) that returns must, by their very definition, equal the sum of expected
returns, shocks to cash flows, and shocks to discount rates. Thus we now ask how much of the
concentration spread can be attributed to persistent differences in cash-flow surprises across
industries with different market structures.

The null hypothesis in this section is that the differences in average returns across con-
centration quintiles are due to persistent, in-sample cash flow shocks that need not persist in
the future. If this is the case, then industry concentration may just happen to explain average
returns during the period of our analysis, but are unrelated to true expected returns. Therefore,
we have no reason to think that these returns differences would continue. Our analysis builds
on Fama and French (2000), Vuolteenaho (2002), and Campbell and Vuolteenaho (2003).

We extend the Fama and French (2000) profitability model by adding lagged profitability,
following Vuolteenaho (2002). Specifically, we are interested in the models of the form

Et Vt Dt Et−1
= α0 + α1 + α2 DDt + α3 + α4 + εt (3)
At At Bt At−1

17
where E/A is earnings scaled by total assets, V /A is the ratio of market value of assets to book
assets, DD is a dummy variable for non-dividend paying firms, and D/B is the ratio of dividend
payments to book equity.7 Expected profitability is the fitted value from this regression, and
unexpected profitability is then the regression error. To estimate this model, we follow Fama
and French (2000), and estimate a cross-sectional regressions each year.

Panel A of Table V presents average coefficients from the cross-sectional regressions for
three profitability specifications. The first row, labelled ‘Firm-Level,’ reports FM regressions
of firm-level profitability on firm-level characteristics. The row labelled ‘Industry Total’ com-
putes a single earnings measure for each industry, and scales this by total industry assets, and
then regresses it on the four independent variables that are constructed similarly. Finally, the
row labelled ‘Industry Average’ reports regressions of the industry average profitability on
industry average values of the variables described above.

Our numbers are a close match to those reported in Table 1 of Fama and French (2000).
Specifically, we obtain statistically positive loadings on D/B and statistically negative loadings
on the dividend dummy. Profitability loads positively and significantly on V/A, suggesting
that V/A captures differences across firms in expected profitability that are missed by the two
dividend variables. Our regression R2 values, ranging from 42% to 50%, are about twice
as high as those reported in Fama and French (2000), due largely to the inclusion of lagged
profitability, as suggested in Vuolteenaho (2002).

In the lower portion of Table V we take the regression errors from Panel A and relate
them to industry concentration. We do this for two measures of unexpected profitability. The
variable UPt is the in-sample regression error from the FM regression reported in Panel A. The
variable UPt+1 is the one-period-ahead regression error. This is the error obtained by using
the FM coefficients from a regression in year t − 1 to forecast the profitability in year t, and
treating this forecast error as unexpected profitability.
7 We also tried specifications including book-to-market and past returns, but these additional variables were
insignificant.

18
 In Panel B, Quintiles 1-5 report the average unexpected profitability by concentration quin-
tile. As in previous tables, quintile 1 is the least concentrated and quintile 5 the most concen-
trated quintile. If the null hypothesis of this section described our results, then we would ex-
pect to see large positive average profitability shocks for quintile 1 and large negative shocks
for quintile 5.

Instead, we see the opposite. Concentrated industries have experienced better than ex-
pected profitability over the 1963-2001 period, while competitive industries have experienced
poorer than expected profitability. Unexpected profitability is increasing as we move towards
more concentrated quintiles. With firm-level UPt and UPt+1 , and with industry level UPt
measures, we can reject the null hypothesis that profitability is the same across all five con-
centration quintiles.

In the far-right column of Panel B, labelled FM, we report FM regressions of UP on indus-

try concentration. These results mirror the findings obtained by quintile breakdowns. In all
but one specification, there is a statistically positive relation between unexpected profitability
and industry concentration. In one case (industry average UPt+1 ) we cannot reject the null
of zero correlation, but we never see results going in the direction that would be required to
support the null hypothesis of this section. In short, differences in unexpected profitability
cannot explain our findings.

If anything, the results from Table V suggest that the pattern we obtain in average returns
would be even stronger in expected returns, if we were to observe them directly. This is
because actual returns are expected returns plus shocks to cash flows and discount rates. Since
the shocks go in the opposite direction of the return spread, this suggests that the true spread
in expected returns is more pronounced than we may observe.

19
V. Concentration and Time Series Variation in Returns

A. Time Series Variation of Industry Concentration Premium

This subsection links changes in the industry concentration premium to various risk factors and
business cycle indicators. This allows us to examine the question of whether the concentration
premium remains significant after controlling for existing risk factors, and also whether the
concentration premium exhibits sensible variation over the business cycle.

In Table VI, we report results from the following time-series regressions of monthly con-
centration premia on risk factors and economic indicators:

I J
λtH = α + ∑ βi Fit + ∑ γ j X jt + εt , (4)
i=1 j=1

where Fit are returns to factor-mimicking portfolios in month t, and X jt are month t values
of the business cycle indicators. The dependent variable, λtH , is the time-series of H(Sales)
risk premia generated from the FM regressions reported in Panel B of Table IV, in which the
cross-section of individual stock returns are regressed on industry concentration, controlling
for other characteristics.

In the first row, the CAPM model is estimated in which the monthly concentration pre-
mium are regressed against the market excess return. The next row employs the Fama and
French (1993) three-factor model where two factor-mimicking portfolios that are associated
with the size effect (SMB) and book-to-market effect (HML) are added to the regression. The
following row adds a momentum factor-mimicking portfolio to the Fama-French factors as in
Carhart (1997) to estimate a four factor model. As the table indicates, the regression intercepts
are both economically and statistically significant in the presence of various risk factors. The
H(Sales) premium drops slightly (in absolute value) from negative 42 basis points (Table IV,
Panel B, last row) to negative 40 per month when regressed on the market excess return. The
adjusted R2 from this regression is close to zero. Controlling for the Fama and French (1993)

20
factors actually increases the premium to -0.46%, whereas the R2 goes up to 16.1%. Adding
the momentum factor decreases the premium to -0.33% (still significant), and there is a slight
increase in the R2 to 19%.

These three sets of regressions show that the concentration premium cannot be explained
by known risk factors, which reinforces the finding in Section III that industry concentration
contains independent information about the cross-section of average returns.

The next three rows regress the concentration premium on the inflation rate, the term
spread, and t-bill rate. (All macro variables are obtained from the Federal Reserve Bank
of St. Louis’ FRED database.) Inflation is measured by the growth rate of the consumer
price index (CPI). The term spread is the difference between ten-year and one-year treasury
constant maturity rates. These variables have been demonstrated by the literature to track
business cycle fluctuations (see, for example, Fama and French (1989)). The results indicate
that the H(Sales) premium carries positive and statistically significant loadings on the inflation
rate and the t-bill rate. Since the H(Sales) premium has a negative mean value, this means that
the concentration premium grows (in absolute value) as the business cycle declines, since both
the inflation rate and the t-bill rate rise during economic expansion and fall during economic
contraction. It also loads negatively on the term spread. Since the term spread tend to decrease
as the business cycle moves from trough to peak, this finding is consistent with the loading on
the inflation rate and the t-bill rate. It indicates that the concentration premium diminishes as
the economy takes an upturn. This is again consistent with a risk interpretation: the spread in
returns between firms that are insulated from economic distress and those that are not grows
as economic conditions deteriorate.8

In addition to examining inflation, T-bill rate, and term premium, we also include current
and future GDP growth rates to directly examine the relation between the concentration pre-
8 The predictive power of these business cycle variables for the concentration premium is low. They at most

explain 4% of the total variation in monthly concentration premium. However, this is not unusual given previous
studies (e.g., Fama and French (1989) and Lewellen (1999)), which document that ex-ante instruments can only
account for a small portion of the time series variation in monthly stock returns.

21
mium and economic activities. The variable labelled ‘gt ’ is the current quarterly GDP growth
rate, while gt+1 is the GDP growth rate over the next four quarters. There is a positive correla-
tion with current GDP growth, but this correlation is not statistically significant. On the other
hand, there is a much larger, and highly significant, correlation with GDP growth over the
next year. This is in line with the results documented in the literature that short horizon stock
returns contains forward-looking information about the strength of economic activities over
many future periods. For example, Fama (1990) and Kothari and Shanken (1992) show that
monthly stock returns are only weakly associated with contemporaneous but are strongly cor-
related with one year ahead growth rates of industrial production. This supports a risk-based
interpretation of the industry concentration effect, since it indicates that the magnitude of the
concentration premium grows as the economic outlook deteriorates. Replacing GDP growth
with industry production growth produces qualitatively similar, but slightly weaker, results.

The last few rows of this table regress the concentration premium on risk factors and
business cycle indicators. Controlling for business cycle movement in addition to factor re-
turns raises the regression intercept and R2 , but also weakens the loading on the inflation rate,
term spread, and t-bill rate, while the loading on one year ahead GDP growth remains highly
significant. Nevertheless, the message remain largely unaltered: the premium associated with
industry concentration is not spanned by existing factors and it exhibits sensible business cycle
variation. The fact that the concentration premium is grows during downturns, when economic
distress is relatively greater, speaks in favor of the hypothesis that industry concentration is a
mechanism through which aggregate shocks are propagated through the equity market.9

In an efficient market where assets are priced rationally, industry concentration must be
proxying for sensitivity to a systematic risk factor in stock returns. In unreported tables,
we follow the logic offered in Fama and French (1993) and employ time series regressions
to explore this question. We find that a mimicking concentration factor captures substantial
9 In unreported tables, we also included cash-flow and discount rate news factors from Campbell and
Vuolteenaho (2003). The concentration premium loads on them in a manner that is consistent with the inter-
pretation offered above.

22
common variation in stock returns that is left unexplained by existing asset pricing factors. In
addition, spread in returns across concentration quintile portfolios is related to the spread in
loadings on the concentration factor. Morever, while existing factor models fail to price these
concentration quintile portfolios, including the concentration mimicking factor completely
explains the industry concentration effect in average returns. All five regression intercepts are
within 10 basis points of 0 and a GRS test cannot reject the null that the constant terms are
jointly zero.

B. Can the Concentration Premium Explain Existing Factors?

Since we show in Table VI that the concentration premium is not spanned by existing asset
pricing factors, we now turn the tables and examine how much of existing asset pricing factors
can be explained by the concentration premium, since the latter is, arguably, better motivated
by economic theories than some of the existing factors that are based on empirical evidence.10
This is presented in Table VII, where we report time-series regressions of existing asset pricing
factors on the conditional H(Sales) premium.

First we regress returns from a number of factor mimicking portfolios on the conditional
H(Sales) premium. This is presented in Panel A of Table VII. The first column, labelled
‘Mean,’ reports the unconditional mean of the mimicking factor returns over the 1963-2001
period. The remaining three columns report the conditional mean, the loading on the condi-
tional H(Sales) premium, and the regression R2 .

The first row examines the excess market return. The unconditional mean of the excess
market return is 47 basis points per month in our sample, but this collapses to a statistically
insignificant 36 basis points when we account for comovement with the H(Sales) premium.
The regression R2 , however, reveals that very little of the variation in the market premium is
explained by the concentration premium.
10 We thank the referee for suggesting this test.

23
 The concentration premium does a better job explaining the size factor, SMB. The size
factor, SMB loads negatively and highly negatively significantly on the conditional H(Sales)
premium, leaving a constant term that is statistically zero. The adjusted R2 indicates that we
explain that 13% of the variation in the size premium with the conditional H(Sales) premium.
This is only a modest success, however, as the unconditional size premium is a statistically
insignificant 21 basis points in our sample.

The concentration premium does less well at explaining the book-to-market factor and mo-
mentum. Momentum does not load statistically significantly on the concentration premium,
and the conditional mean of the momentum factor is only slightly different than the uncondi-
tional mean.

Interestingly, the concentration premium does not explain away the book-to-market fac-
tor, it enhances it. HML loads significantly positively on the conditional H(Sales) premium,
and the concentration premium explains 12% of the variation in HML. But the mean of HML
increases from 42 basis points per month unconditionally to 59 basis points per month con-
ditionally. This conditional mean HML value is highly statistically significant (and different
than the unconditional value).

In Panel B of Table VII we replace the asset pricing factors with the factor premia obtained
from cross-sectional FM regressions. We focus on size, book-to-market, and a firm’s lagged 1-
year return. The results largely mirror those obtained in Panel A, with size premium explained
away, momentum premium unexplained, and book-to-market premium enhanced. This points
to an interesting interaction between concentration and the book-to-market premium, which
we take up in more detail in the next section.

24
VI. Value, Growth and Industry Concentration

Based on the fact that the book-to-market premium grows in magnitude when we control for
industry concentration, we turn next to FM regressions that explore the interaction of book-
to-market and concentration. These are presented in Panel A of VIII. Returns are at the firm
level (as in Panel B of Table IV) and the final column is an interaction term between industry
concentration and firm-level book-to-market ratio. The coefficient on the interaction terms is
positive and statistically significant, suggesting that the premium associated with being a high
book-to-market firm grows as industry concentration increases.

To get a sense of the economic magnitude involved here, next we examine returns to book-
to-market portfolios for different levels of industry concentration in a five-by-five grid. At
the end of June of each year, we sort industries into concentration quintiles according to their
concentration (H(Sales)) value. Then within each industry, we calculate quintile breakpoints
for book-to-market and place firms into five portfolios.11 Finally, within each concentration
group, we pool firms with the same book-to-market ranking into one portfolio and calculate
the average returns from July to June of the following year. Our sorting approach also guaran-
tees that one industry with particularly large variation in book-to-market does not dominate the
tail portfolios of the five-by-five grid; instead, there is equal representation across industries in
each book-to-market quintile. Panel B of VIII reports the average value-weighted monthly re-
turns of the five book-to-market portfolios as well as the difference in returns between quintile
5 and 1 for each H(Sales) group, while Panel C reports equally weighted returns. Each row
demonstrates the prevalence of the book-to-market effect within each concentration group.

As the table indicates, the spread in returns associated with book-to-market ratio is the
largest among the most concentrated industries. For example, high book-to-market stocks
outperform low book-to-market stocks by 47 basis points per month in the lowest Herfind-
11 Using within-industry breakpoints addresses the fact that the across-industry variation in the book-to-market
ratio is not important for average stock returns; instead, most of the effect is the result of within-industry variation
(Asness and Stevens (1996),Cohen, Polk, and Vuolteenaho (2003)).

25
ahl quintile, and this number grows to 76 basis points per month for the highest Herfindahl
quintile. These double-sorted portfolio results reinforce the findings from the cross-sectional
regressions, which show that the book-to-market premium grows as industry concentration
increases.

Most important, these double-sort portfolios give us critical insights into the relation be-
tween market structure, value and growth. Prior research has examined the book-to-market
ratio as a risk proxy related to relative profitability or distress and yielded mixed results.12
One possible explanation for this is that most studies focus on the average firms, whereas
our results suggest that firms with the same level of book-to-market ratio are fundamentally
different from one another depending on the market structure of the industry in which they
operate. A low book-to-market firm in a concentrated industry is not well described as a
‘growth firm.’ This firm operates in an industry with a large asset, high unit profitability, low
R&D, and subsequently has high capitalized future profitability. Its book-to-market is low not
because its growth prospects are high, but because it is profitable, and expected to continue
to be profitable into the future for reasons potentially associated with barriers to entry. High
profitability, low risk firms are thus being labelled ‘growth’ firms, pulling down the average
returns of low book-to-market stocks.

On the other hand, a low book-to-market stock in a competitive industry is indeed better
characterized as a growth firm. These firms engage in more R&D on average, are less prof-
itable, and thus the low market-to-book is not a reflection of high capitalized profitability, but
rather of expected growth. Growth is risky, and this shows up in higher expected returns.

If we interpret book-to-market as a proxy for distress, then these findings help us to dis-
tinguish between the creative destruction and barriers to entry hypotheses offered in Section I.
These findings favor the innovation risk interpretation, since the spreads in industry concen-
tration are largest in the portion of the book-to-market spectrum where growth is most salient.
12 For evidence on the link between book-to-market and distress, see Fama and French (1995), Chen and Zhang

(1998), Liew and Vassalou (2000), Shumway (1996), or Griffin and Lemmon (2002).

26
Among high book-to-market firms, where it is often argued that distress is more salient, we
see a smaller spread in returns across concentration quintiles.

VII. Conclusion

One of the fundamental questions in empirical asset pricing is what are the economic determi-
nants of the cross-section of stock returns. This is especially important given the large body of
recent research documenting return predictability based on a host of empirically motivated fi-
nancial characteristics. We attack this question from a new perspective, offering evidence that
industry concentration—a feature of the product markets in which firms operate—is important
for understanding stock returns.

Our main thesis is simple. We begin from the widely accepted premise that stock returns
must reflect the risk associated with a firm’s cash flows. We argue that the structure of the
product markets in which these cash flows arise helps to determine this risk by affecting the
equilibrium operating decisions that firms make. In particular, drawing on classic work in in-
dustrial organization from Schumpeter (1912) and Bain (1954), we link industry concentration
to stock returns through innovation and distress risk.

We show that firms in less concentrated industries earn higher stock returns, even after
controlling for the usual suspects that affect the cross-section of average returns, such as size,
book-to-market and momentum. This holds both at the industry level and the firm level and is
robust to alternative empirical specifications. It is not explained by differences in unexpected
returns, and it has been a persistent feature of stock returns since the Great Depression.

These results suggest a number of fruitful areas for future research. First and foremost,
our empirical evidence suggests a need for asset-pricing models which explicitly incorporate
features of product markets as determinants of asset returns. A more rigorous theory of why

27
asset prices are affected by market structure will allow for a more careful exploration of the
link that we have demonstrated to be important in this paper.

Second, we have argued in this paper that either innovation or distress risk is a likely
culprit for the concentration premium. Our preliminary findings support an innovation risk
interpretation, but clearly more work is needed to disentangle these potentially overlapping
hypotheses. We find that the concentration spread in returns is larger for low book-to-market
stocks than high book-to-market stocks. One interpretation is that low book-to-market stocks
in concentrated industries have low returns because they have high capitalized future prof-
itability and engage in less innovation, while low book-to-market stocks in less concentrated
industries have higher returns because they engage in more innovative activity and thus have
higher expected growth rates. This suggests that the link between value, growth and product
market structure is an important question for future work.

Finally, this paper primarily focuses on the unconditional roles played by industry charac-
teristics for understanding the equilibrium tradeoff between risk and return. However, much
of the recent literature in empirical asset pricing uses industry membership as conditioning
information, and explores whether certain asset-pricing phenomena are attributable to indus-
try effects. A better understanding of how industry characteristics affect expected returns can
potentially yield insights into why many stylized facts about stock returns seem to contain
important industry components.

In our view, this concentration premium is better interpreted as compensation for a risk
associated with operating in a less concentrated industry. Of course, the alternative is that some
behavioral bias causes investors to undervalue firms in less concentrated industries, producing
high returns ex post. However, any behavioral explanation must confront a series of facts.
The concentration premium exhibits sensible business cycle variation, growing in magnitude
as expected future growth opportunities deteriorate. Moreover, there is substantial common
variation in stock returns that is related to industry concentration.

28
 The findings in this paper ultimately raise more questions than they answer. Are there
other mechanisms through which market structure affects stock returns? What is the impact
of this on firms’ investment and financing decisions? How does this impact the diffusion of
information in the market? Is the geographic scope of the industry important (national vs.
local product markets)? The story we propose in this paper is a reduced form version of
a more complicated analysis in which product markets affect investment opportunities and
decisions about investment and capital structure. Ultimately, a better understanding of the
precise mechanisms that link these phenomena is required. We leave these issues for future
work.

29
References
Almazan, Andres, and Carlos Molino, 2001, Intra-industry capital structure dispersion, Work-
ing Paper, University of Texas.

Asness, Clifford, and Ross Stevens, 1996, Intra-industry and inter-industry factors in the cross-
section of expected stock returns, Working Paper, Goldman Sachs Asset Management.

Bain, Joe, 1954, Economies of scale, concentration and entry, American Economic Review 44.

Barclay, Michael J., and Clifford W. Smith, 1995, The maturity structure of corporate debt,
Journal of Finance 50, 609–631.

Berger, Philip, and Eli Ofek, 1995, Diversification’s effect on firm value, Journal of Financial
Economics 37, 39–65.

Campbell, John Y., 1991, A Variance Decomposition for Stock Returns, Economic Journal
101, 157–179.

Campbell, John Y., and Robert J. Shiller, 1988, The dividend-price ratio and expectations of
future divdends and discount factors, Review of Financial Studies 1, 195–228.

Campbell, John Y., and Tuomo Vuolteenaho, 2003, Good Beta, Bad Beta, Working Paper,
Harvard University.

Carhart, Mark M., 1997, On persistence in mutual fund performance, Journal of Finance 52.

Chen, Nai-Fu, and Feng Zhang, 1998, Risk and returns of value stocks, Journal of Business
71, 501–535.

Cohen, Randolph, Christopher Polk, and Tuomo Vuolteenaho, 2003, The Value Spread, Jour-
nal of Finance 58.

Daniel, Kent, Mark Grinblatt, Sheridan Titman, and Russ Wermers, 1997, Measuring mutual
fund performance with characteristics-based benchmarks, Journal of Finance 52.

Davis, Jim, Eugene F. Fama, and Kenneth French, 2000, Characteristics, Covariances, and
Average Returns: 1929-1997, Journal of Finance 55, 389–406.

30
Fama, Eugene, and Kenneth French, 2000, Forecasting Profitability and Earnings, Journal of
Business 73, 161–175.

Fama, Eugene F., 1976, Foundations of Finance. (Basic Books New York).

Fama, Eugene F., 1990, Stock Returns, Expected Returns, and Real Activity, Journal of Fi-
nance 45, 1089–1108.

Fama, Eugene F., 1998, Determining the Number of Priced State Vectors in the ICAPM,
Journal of Financial and Quantitative Analysis 33, 217–231.

Fama, Eugene F., and Kenneth R. French, 1989, Business conditions and expected returns on
stocks and bonds, Journal of Financial Economics 25, 23–49.

Fama, Eugene F., and Kenneth R. French, 1992, Common risk factors in the returns on stocks
and bonds, Journal of Financial Economics 33.

Fama, Eugene F., and Kenneth R. French, 1993, Common risk factors in the returns of bonds
and stocks, Journal of Financial Economics 33, 3–56.

Fama, Eugene F., and Kenneth R. French, 1995, Size and book-to-market factors in earnings
and returns, Journal of Finance 50, 131–155.

Fama, Eugene F., and James MacBeth, 1973, Risk, return, and equilibrium: empirical tests,
Journal of Political Economy 81, 607–636.

Geroski, P. A., 1990, Innovation, Technological Opportunity, and Market Structure, Oxford
Economic Papers 42, 586–602.

Griffin, John, and Michael Lemmon, 2002, Book-to-market equity, distress risk, and stock
returns, Journal of Finance 57, 2317–2336.

He, Kathy, Randall Mørck, and Bernard Yeung, 2003, Corporate Stability and Economic
Growth, Working Paper, University of Alberta.

Hou, Kewei, 2003, Industry information diffusion and the lead-lag effect in stock returns,
Working Paper, Ohio State University.

31
Kahle, Kathleen M., and Ralph A. Walkling, 1996, The impact of industry classifications on
financial research, Journal of Financial and Quantitative Analysis 31, 309–335.

Knott, Anne Marie, and Hart Posen, 2003, Does Competition Increase Innovation? New
evidence from Old Industries, Working Paper, Mack Center for Technological Innovation.

Kothari, S.P., and Jay Shanken, 1992, Stock return variation and expected dividends: a time-
series and cross-sectional analysis, Journal of Financial Economics 31, 177–210.

Lewellen, Jonathan, 1999, The time-series relations among expected return, risk, and book-
to-market, Journal of Financial Economics 54, 5–43.

Liew, Jimmy, and Maria Vassalou, 2000, Can book-to-market, size and momentum be risk
factors that predict economic growth?, Journal of Financial Economics 57, 221–245.

Mackay, Peter, and Gordon Phillips, 2002, Is there an optimal industry financial structure?,
NBER Working Paper.

Merton, Robert C., 1973, An intertemporal capital asset pricing model, Econometrica 41,
127–147.

Modigliani, Franco, and Merton Miller, 1958, The Cost of Capital, Corporation Finance, and
the Theory of Investment, American Economic Review 48, 261–297.

Moskowitz, Tobias J., and Mark Grinblatt, 1999, Do industries explain momentum, Journal
of Finance 54, 1249–1290.

Rajan, Raghuram, Henri Servaes, and Luigi Zingales, 2000, The cost of diversity: the diversi-
fication discount and inefficient investment, Journal of Finance LV, 35–80.

Reinganum, Jennifer, 1985, Innovation and Industry Evolution, Quarterly Journal of Eco-
nomics 100, 81–99.

Ross, Steven A., 1976, The arbitrage theory of asset pricing, Journal of Economic Theory 13,
341–360.

Salop, Steven C., 1979, Strategic Entry Deterrence, American Economic Review 69, 335–338.

32
Schmalensee, Richard, 1978, Entry Deterrence in the Ready-to-Eat Breakfast Cereal Industry,
The Bell Journal of Economics 9, 305–327.

Schmalensee, Richard, 1981, Economies of Scale and Barriers to Entry, Journal of Political
Economy 89, 1228–1238.

Schumpeter, Joseph, 1912, The Theory of Economic Development. (Harvard University Press
Cambridge, Mass).

Schumpeter, Joseph, 1942, Capitalism, Socialism, and Democracy. (Harper & Row).

Shumway, Tyler, 1996, Size, overreaction, and book-to-market effect as default premia, Work-
ing Paper, University of Michigan.

Shumway, Tyler, 1997, The delisting bias in CRSP data, Journal of Finance 52, 327–340.

Sutton, John, 1991, Sunks Costs and Market Structure: Price Competition, Advertising, and
the Evolution of Concentration. (MIT Press Cambridge).

Sutton, John, 1998, Technology and Market Structure: Theory and History. (MIT Press Cam-
bridge).

Titman, Sheridan, 1984, The effects of capital structure and a firm’s liquidation decision,
Journal of Financial Economics 13, 137–151.

Vuolteenaho, Tuomo, 2002, What Drives Firm Level Stock Returns?, Journal of Finance 57,
233–264.

33
 Table I
Summary Statistics

The sample includes all NYSE/AMEX/NASDAQ listed securities with sharecodes 10 or 11 that are contained in the intersection of the CRSP monthly returns file and the COMPU-
STAT industrial annual file between July, 1963 and December, 2001.Panel A reports summary statistics of industry concentration measures for 3-digit SIC industries.The H(Sales)
for an industry is formed by first calculating the sum of squared sales-based market shares of all firms in that industry in a given year and then averaging over the past three years.
H(Assets) and H(Equity) are computed analogously, only using total assets and book equity in place of sales. The The right-most columns present Spearman and Pearson correlations
between industry concentration measures. Spearman (rank) correlations are presented below the main diagonal, Pearson above. Panel B reports average characteristics of quintile
portfolios sorted by H(Sales). Quintile 1 corresponds to the 20% of industries with the lowest concentration, while quintile 5 corresponds to the 20% of industries with the highest
concentration. Newlist is the average number of newly listed firms per year in each quintile. Delists is the average number of de-listed firms per year. Size (market equity) is CRSP
price times shares outstanding (in millions of dollars). Assets is COMPUSTAT Total Assets. Sales is COMPUSTAT Net Sales. E/A is earnings before interest (income before
extraordinary items + interest expense + income statement deferred tax) divided by assets; E/S is earnings divided by sales. V/A is market value of firm (market equity + total assets
- book equity) divided by total assets. D/B is the ratio of dividends to book equity. Book equity is stockholder’s equity (or common equity + preferred stock par value, or asset -
liabilities) plus balance sheet deferred taxes and investment tax credit minus the book value of preferred stock and post retirement asset. R&D/A is the ratio of R&D expenditure to
total assets. Lev. is the ratio of book liabilities (total assets - book equity) to total market value of firm. B/M is the ratio of book equity to market equity. Beta is post-ranking beta as
in Fama and French (1992). Each of these characteristics are calculated at the firm-level and then averaged within each H(Sales) quintile.

Panel A: Summary of Industry Concentration Measures

34
Spearman-Pearson Correlation:
Mean Median STD Max Min 20% 40% 60% 80% H(Sales) H(Assets) H(Equity)
H(Sales) 0.544 0.490 0.310 1.000 0.025 0.231 0.385 0.611 0.944 1.000 0.976 0.951
H(Assets) 0.549 0.499 0.307 1.000 0.024 0.233 0.397 0.618 0.936 0.976 1.000 0.964
H(Equity) 0.546 0.502 0.308 1.000 0.024 0.230 0.405 0.609 0.931 0.953 0.966 1.000

Panel B: Characteristics of H(Sales) Sorted Quintile Portfolios

Rank H(Sales) Newlist Delists Size Asset Sales E/A E/S V/A D/B R&D R&D/A Lev. B/M Beta
Low 0.133 267.40 214.60 531.3 1200.4 582.5 0.013 0.110 1.293 0.026 35.293 0.075 0.437 0.798 1.579
2 0.287 126.21 84.70 527.8 645.1 509.6 0.029 0.111 1.257 0.024 21.226 0.060 0.399 0.742 1.632
3 0.470 60.47 42.70 607.4 1204.8 786.7 0.036 0.116 1.327 0.031 21.759 0.040 0.432 0.809 1.595
4 0.745 41.51 23.82 606.4 1087.9 629.3 0.038 0.124 1.558 0.041 17.164 0.037 0.428 0.787 1.606
High 0.982 20.13 8.68 431.3 1604.9 717.6 0.037 0.136 1.695 0.036 13.059 0.027 0.421 0.767 1.609
 Table II
Fama-MacBeth Regressions of H(Sales) on Industry Average Characteristics

This table presents Fama-Macbeth regressions of the H(Sales) index with other industry average characteristics. The variables are defined according to Table
I. Every year, a cross-sectional regression is estimated. The time-series mean of the annual regression coefficients and the time-series t-statistics (appearing
below) are reported. In Panel A, each coefficient is obtained from a simple (univariate) regression of H(Sales) on each characteristic alone. Panel B reports the
results of multiple (multivariate) regressions of H(Sales) on a series of industry characteristics.

Panel A: Simple Regressions

ln(Size) ln(Assets) ln(Sales) E/A E/S V/A D/B R&D/A Leverage ln(B/M) Beta
-0.040 -0.032 -0.043 0.179 0.213 0.014 -0.002 -0.984 -0.033 -0.028 0.091
-13.45 -17.97 -22.81 4.77 7.15 3.71 -0.02 -4.97 -1.73 -5.34 4.92

Panel B: Multiple Regressions

35
ln(Size) ln(Assets) ln(Sales) E/A E/S V/A D/B R&D/A Leverage ln(B/M) Beta
-0.034 0.522 -1.443 -0.056 -0.057 -0.011
-3.89 3.28 -6.99 -0.84 -6.08 -0.23
-0.027 0.525 -1.527 0.026 -0.044 0.021
-3.26 3.32 -7.22 0.44 -3.75 0.46
-0.027 0.489 -1.514 0.012 -0.036 0.021
-4.09 2.50 -7.26 0.20 -3.35 0.55
-0.039 0.580 -1.399 -0.017 -0.056 -0.016
-4.36 7.57 -6.81 -0.24 -5.80 -0.38
-0.023 0.024 -1.487 -0.114 0.019
-1.91 4.23 -7.05 -1.80 0.36
-0.034 0.542 0.570 -1.361 -0.043 -0.044 0.011
-3.84 3.21 2.97 -6.75 -0.64 -3.83 0.22
 Table III
Industry Concentration and the Cross-Section of Average Stock Returns

In June of each year, industries are grouped into quintiles based on their H(Sales) value. The average monthly returns (in percent) of the quintile portfolios are
reported, as well as the difference between Quintile 5 (most concentrated) and 1 (least concentrated). We report t-statistics below average returns. Firm-level
raw returns are unadjusted returns averaged across firms within the same concentration quintile. Firm-level adjusted returns are calculated by subtracting the
return on a characteristic-based benchmark from each firm’s return, then averaging within the same concentration quintile. Characteristic-based benchmarks
are constructed following Daniel, Grinblatt, Titman, and Wermers (1997) to account for the premia associated with size, book-to-market, and momentum.
Industry-level raw and adjusted returns are computed similarly, except that individual stock raw and adjusted returns are first averaged within each industry,
and then averaged across industries within the same concentration quintile. During the 1927 to 1951 sample period, H(Sales) is replaced by H(Equity). This is
constructed from Davis, Fama, and French (2000) data.

Firm-Level Returns Industry-Level Returns

Quintile Quintile
1 2 3 4 5 5-1 1 2 3 4 5 5-1

Raw and Adjusted Returns, 63/07-01/12

Raw 1.52 1.28 1.38 1.26 1.26 -0.26 1.35 1.29 1.30 1.24 1.09 -0.26

36
5.02 4.37 4.55 4.3 4.43 -2.14 4.71 4.39 4.58 4.2 3.74 -2.35
Adjusted 0.26 0.00 0.02 -0.03 -0.10 -0.36 0.09 -0.02 -0.09 -0.15 -0.18 -0.28
3.81 0.07 0.34 -0.76 -2.60 -3.8 2.59 -0.55 -1.77 -2.61 -1.80 -2.34

Adjusted Returns, alternative sample periods

27/01-01/12 0.11 -0.01 0.05 -0.02 -0.04 -0.15 0.06 0.00 -0.08 -0.07 -0.12 -0.17
2.18 -0.26 1.21 -0.59 -1.33 -2.43 2.16 -0.03 -2.19 -1.74 -1.69 -2.18
51/07-01/12 0.21 0.00 -0.01 -0.03 -0.07 -0.28 0.07 -0.02 -0.08 -0.09 -0.13 -0.20
3.94 -0.05 -0.21 -0.78 -2.29 -3.83 2.57 -0.64 -2.15 -2.05 -1.71 -2.29
74/01-01/12 0.31 0.02 0.01 -0.03 -0.13 -0.44 0.05 -0.05 -0.06 -0.15 -0.30 -0.35
3.75 0.29 0.10 -0.62 -2.79 -3.8 2.56 -1.13 -0.97 -2.32 -2.62 -2.88

Adjusted Returns, alternative concentration measures, 63/07-01/12

H(assets) 0.09 0.17 0.01 -0.02 -0.12 -0.20 0.10 -0.03 -0.13 -0.08 -0.16 -0.26
1.19 2.64 0.39 -0.44 -2.95 -2.12 2.95 -0.75 -2.72 -1.42 -1.49 -2.12
H(equity) 0.16 0.12 0.05 -0.10 -0.08 -0.24 0.11 -0.09 -0.09 -0.11 -0.16 -0.27
2.30 2.20 0.95 -2.19 -2.09 -2.52 3.24 -2.16 -1.85 -1.80 -1.54 -2.28
Segment-level 0.18 -0.14 -0.26 -0.44 -0.45 -0.63 0.47 0.09 0.07 -0.20 -0.27 -0.74
H(Sales) 2.54 -1.83 -2.66 -3.83 -2.27 -2.75 2.89 0.94 0.86 -2.56 -3.40 -3.32
 Table IV
Fama-Macbeth Cross-Sectional Regressions of Industry-Level and Firm-Level Returns

This table presents results from industry-level (Panel A) and firm-level (Panel B) Fama-MacBeth cross-sectional regressions estimated
monthly between July, 1963 and December, 2001. In Panel A, industry average returns are regressed on industry H(Sales) measure, industry
average values of ln(Size), ln(B/M), Leverage, Beta, and the past one-year return on the industry portfolio (Momentum). In Panel B,
individual stock returns are regressed on H(Sales) value of the industry to which each stock belongs, firm-level ln(Size), ln(B/M), Leverage,
Beta, and the past one-year stock return (Momentum). Time-series average values of the monthly regression coefficients are reported with
time-series t-statistics appearing below.
Panel A: Industry-Level Regressions
H(Sales) ln(Size) ln(B/M) Momentum Beta Leverage
-0.30
-2.41
-0.12
-1.54
0.39
4.16
1.03
4.21
-0.30 -0.12 0.29 0.90
-2.58 -1.57 3.07 3.93
-0.18
-0.43
0.98
2.96
-0.24 0.28 0.95 -0.95 0.08
-2.81 2.77 4.40 -2.56 0.24
-0.31 -0.25 0.27 0.94 -1.00 0.04
-2.85 -2.98 2.68 4.36 -2.73 0.12
Panel B: Firm-Level Regressions
H(Sales) ln(Size) ln(B/M) Momentum Beta Leverage
-0.35
-2.41
-0.14 0.35 0.56
-2.62 4.55 3.34
-0.44 -0.14 0.35 0.55
-3.75 -2.63 4.62 3.32
0.26
0.90
0.76
2.81
-0.18 0.38 0.60 -0.39 -0.30
-3.78 6.41 3.81 -1.87 -1.56
-0.42 -0.18 0.39 0.59 -0.41 -0.33
-3.42 -3.81 6.62 3.78 -1.95 -1.70
37
 Table V
Industry Concentration and Profitability Surprises

This table examines the relation between profitability surprises and industry concentration. Firm-level E/A is firm-level earnings to assets.
Industry total (E/A) is the total earnings in the industry divided by total assets of the industry. Industry average E/A is the industry average
earnings-to-assets ratio. Expected profitability is obtained from Fama-MacBeth regressions of the form

Et Vt Dt Et−1
= α0 + α1 + α2 DDt + α3 + α4 + εt
At At Bt At−1

following Fama and French (2000) and Vuolteenaho (2002). Unexpected profitability is the regression error from this regression. In Panel
B, we group industries according to concentration quintiles and report average unexpected profitability. The variable UPt is the unexpected
profitability from in-sample regressions, while UPt+1 is the regression error obtained by predicting next year’s profitability using next year’s
regressors but parameter values obtained from year t. The two Test columns report the F-statistic for the joint equality of quintiles 1 through
5, as well as the t-statistic for the equality of quintiles 1 and 5. The final column reports the Fama-Macbeth coefficient from a regression of
unexpected profitability on the H(Sales) index.
Panel A: Expected Profitability Regressions
Profitability Measure α0 V/A DD D/B ROAt−1 Avg. R2
Firm-level E/A 0.0187 0.0120 -0.0164 0.0679 0.5341 0.4267
11.91 7.46 -8.19 7.12 34.38
Industry Total (E/A) 0.0089 0.0136 -0.0027 0.0890 0.5684 0.5099
5.69 9.53 -0.69 5.13 25.95
Industry Average E/A 0.0196 0.0139 -0.0132 0.0801 0.5130 0.4600
10.69 7.34 -6.02 4.05 27.88

Panel B: Unexpected Profitability by Concentration Quintile

Profitability: Quintiles Tests
Firm-level 1 2 3 4 5 F (1=2=3=4=5) t (1=5) FM
UPt -0.0017 0.0014 0.0041 0.0025 0.0023 5.95 3.07 0.0101
-4.14 2.45 3.96 2.90 1.88 0.0002 0.0036 4.49
UPt+1 -0.0043 -0.0013 0.0029 0.0024 0.0002 2.81 1.65 0.0124
-1.98 -0.76 1.97 1.47 0.14 0.0268 0.1035 2.85
Industry Total
UPt -0.0013 -0.0007 0.0007 0.0004 0.0025 3.06 2.58 0.0043
-2.48 -1.25 1.06 0.49 1.81 0.0179 0.0131 2.66
UPt+1 -0.0015 -0.0014 0.0004 -0.0008 0.0014 0.65 1.27 0.0038
-1.07 -0.83 0.30 -0.61 0.77 0.6268 0.2065 2.01
Industry Average
UPt -0.0018 0.0002 0.0015 -0.0004 0.0013 2.95 2.31 0.0031
-3.70 0.32 2.10 -0.60 1.05 0.0214 0.0254 2.21
UPt+1 -0.0030 -0.0005 0.0001 -0.0015 0.0007 1.08 1.79 0.0026
-2.19 -0.39 0.04 -1.16 0.47 0.3699 0.0773 1.36

38
 Table VI
Time Series Variation of the Concentration Premium
This table presents results from time-series regressions of the H(Sales) premium on various asset-pricing factors and business cycle indicators. The
H(Sales) premium is obtained from monthly Fama-MacBeth cross-sectional regressions of stock returns on industry H(Sales) index, controlling for
other characteristics (see the last row of Table IV Panel B). RMRF is the market excess return. SMB and HML are size and B/M factor mimicking
returns (see Fama and French (1993) for description). MOM is the momentum factor as in Carhart (1997). The factor data was downloaded from
Ken French’s website. INF is the monthly rate of inflation, obtained from the St. Louis Federal Reserve Economic Database (FRED). Term is the
term spread, the difference between ten-year and one-year treasury constant maturity rates. T-bill is the 30-day t-bill rate. gt and gt+1 are the current
and next four quarters’ growth rates in GDP, also obtained from FRED. Alpha is the intercept from time series regression. T-statistics are reported
below parameter estimates.

Alpha RMRF SMB HML MOM INF Term T-Bill gt gt+1 Adj. R2
-0.40 -0.049 0.0072
-3.87 -1.99
-0.46 0.0416 -0.2171 0.1729 0.1608
-4.27 1.32 -3.13 2.74
-0.33 0.0341 -0.217 0.1225 -0.1129 0.1904
-3.4 1.14 -3.41 2.49 -2.83
-1.02 1.44 0.0263
-4.37 3.75
-0.59 -0.9313 0.0406
-4.49 -4.56
-1.08 0.1011 0.0106
-4.16 3.27
-2.02 0.0661 0.1324 0.0449
-3.79 0.71 3.15
-0.84 0.0435 -0.2149 0.1202 -0.1118 1.2163 0.2086
-4.43 1.45 -3.46 2.48 -2.85 3.53
-0.49 0.042 -0.2253 0.1078 -0.1118 -0.8871 0.227
-4.33 1.44 -3.63 2.3 -2.89 -4.82
-0.90 0.0403 -0.216 0.1219 -0.1135 0.0877 0.1981
-3.63 1.35 -3.41 2.49 -2.86 2.61
-2.04 0.0374 -0.2348 0.1069 -0.1106 0.1109 0.1358 0.2419
-5.33 1.27 -3.89 2.38 -3.02 1.15 4.47
-0.50 0.0435 -0.2239 0.1081 -0.1111 0.6036 -0.8156 -0.0349 0.2263
2.47 1.48 -3.64 2.31 -2.89 1.55 -3.82 -0.88
-2.36 0.0426 -0.2325 0.1064 -0.1108 0.2096 -0.0303 0.0576 0.0775 0.1282 0.2433
-3.36 1.45 -3.85 2.34 -3.01 0.54 -0.1 1.19 0.77 2.87

39
 Table VII
Can the Concentration Premium Explain Existing Factors?

This table reports results from time-series regressions of mimicking portfolio returns and cross-sectional premia of asset-
pricing factors on the conditional H(Sales) premium. In Panel A, the dependent variables are factor mimicking returns
obtained from Ken French’s website. RMRF is the market excess return. SMB and HML are size and B/M factor mimicking
returns (see Fama and French (1993) for description). MOM is the momentum factor as in Carhart (1997). In Panel B,
the dependent variables are cross-sectional premia obtained from monthly Fama-Macbeth regressions of stock returns on
ln(Size), ln(B/M), and Momentum. The column labelled ‘Mean’ is the average value of the factor mimicking return or
premium. Alpha is the regression intercept from regressing factor return/premium on H(Sales) Premium. The column
labelled ‘H(Sales) Premium’ reports the loading of the factor/premium on H(Sales) premium. The final column reports the
adjusted R2 of the regression. Point estimates are reported with t-statistics appearing below.

Panel A: Explaining Factor Returns

LHS Mean Alpha H(Sales) Premium Adj. R2
RMRF 0.47 0.36 -0.2827 0.02
2.26 1.66 -3.31
SMB 0.21 0.00 -0.5055 0.13
1.35 0.00 -4.56
HML 0.42 0.59 0.4410 0.12
2.98 4.31 6.23
MOM 0.87 0.82 -0.1430 0.01
4.75 4.69 -0.82

Panel B: Explaining Cross-Sectional Factor Premia

LHS Mean Alpha H(Sales) Premium Adj. R2
Size Premium -0.13 -0.09 0.1194 0.07
-2.65 -1.77 3.38
B/M Premium 0.35 0.44 0.2331 0.13
4.83 6.48 5.41
Momentum Premium 0.56 0.58 0.0400 0.00
3.54 3.81 0.42

40
 Table VIII
Interaction between Industry Concentration and Book-to-Market Effects

Panel A presents results from monthly Fama-MacBeth cross-sectional regressions of individual stock returns on ln(Size), ln(B/M), Momentum,
Beta, Leverage, H(Sales), and an interaction term between H(Sales) and ln(B/M). Time-series averages of the monthly regression coefficients, in
percent, are reported with time-series t-statistics below. Panels B and C report value-weighted (Panel B) and equal-weighted (Panel C) average
returns of B/M quintile portfolios, their t-statistics, and the difference in returns between quintile 5 and 1 within each concentration quintile. 2-digit
SIC Industries are first sorted into concentration quintiles based on their H(Sales) value. Firms within each industry are then sorted into quintiles
based on their B/M. Finally, firms with the same B/M ranking from industries within the same concentration quintile are grouped into one portfolio
to create the 5x5 double-sorted portfolios on H(Sales) and B/M. The row entitled ‘All’ reports average returns of B/M quintiles formed across
concentration quintiles.
Panel A: Fama-MacBeth Cross-Sectional Regressions
ln(Size) ln(B/M) Momentum Beta Leverage H(Sales) H(Sales)*ln(B/M)
-0.19 0.29 0.59 -0.41 -0.32 -0.37 0.25
-3.82 3.76 3.78 -1.99 -1.65 -3.14 2.38
Panel B: Value-Weighted Average Returns of H(Sales) and B/M Sorted Portfolios
H(Sales) B/M Quintiles
Quintiles 1 (Low) 2 3 4 5 (High) 5-1 spread
1 (Low) 1.11 1.26 1.24 1.42 1.58 0.47
4.01 5.13 4.45 5.22 4.49 2.11
2 0.84 1.08 1.26 1.51 1.45 0.61
3.23 4.33 4.93 5.95 5.23 2.80
3 0.98 1.04 1.13 1.32 1.64 0.65
3.52 3.78 4.31 4.77 5.87 2.59
4 0.74 0.99 1.21 1.21 1.45 0.71
2.85 3.93 5.27 4.74 5.07 3.35
5 (High) 0.62 1.03 1.05 1.33 1.38 0.76
1.93 3.02 3.22 5.28 3.75 2.11
All 0.85 1.03 1.13 1.32 1.50 0.66
3.31 4.65 5.11 5.73 5.78 3.19
Panel C: Equally Weighted Average Returns of H(Sales) and B/M Sorted Portfolios
H(Sales) B/M Quintiles
Quintiles 1 (Low) 2 3 4 5 (High) 5-1 spread
1 (Low) 0.81 1.34 1.31 1.61 1.83 1.02
2.58 4.18 4.61 5.62 5.98 6.84
2 0.78 1.07 1.40 1.54 1.81 1.03
2.47 3.80 5.07 5.64 6.28 6.99
3 0.70 0.99 1.34 1.56 1.82 1.13
2.09 3.24 4.53 5.43 5.92 6.49
4 0.68 1.02 1.30 1.33 1.85 1.17
1.89 3.40 4.41 4.50 5.91 4.70
5 (High) 0.15 0.97 1.10 1.17 1.59 1.43
0.32 2.41 3.18 3.28 4.11 3.36
All 0.76 1.15 1.36 1.56 1.81 1.05
2.47 3.97 4.92 5.68 6.22 8.12
41