It’s Good^K^K^K^KBad to Be King

Monopolists make all the money, right? Not so fast. One of my favorite results in recent economics research is this one by Hou and Robinson from their August paper (“Industry Concentration and Average Stock Returns”) in the Journal of Finance. It neatly blows up the idea that the most profitable companies are the ones that have the largest share of their markets:

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.

Whoa, so why might that be? Plenty of reasons come to mind, not least of which is the complacency of monopolists, the sleepy industries in which monopolists thrive, and so on. Hou and Robinson suggest something similar:

Drawing on work in industrial organization, we posit that either
barriers to entry in highly concentrated industries insulate firms from
undiversifiable distress risk, or firms in highly concentrated
industries are less risky because they engage in less innovation, and
thereby command lower expected returns. Additional time-series tests
support these risk-based interpretations.

Fascinating stuff.


  1. Ron Durbin says:

    Here’s an off-the-beaten-track article that came to mind when reading this post – It outlines an academic view that competition is healthy for industry participants. Red Queen theory always comes to my mind when I think about monopolies.

  2. Sure, monopolies may grow fat and complacent and return shareholders much the same as competitive companies…
    But companies usually are run for the benefit of management; and management of a monopoly enjoys life a lot more than management of a company with competitors, that fat and complacency benefit them, not the shareholders.
    Because I suspect that monopolistic companies are less subject to takeover risk…

  3. Brent Buckner says:

    One reason for an industry being concentrated is that it has undergone consolidation. One reason an industry undergoes consolidation is that it is in a low-growth/low-profitability situation.