Capital allocation, stock return volatility and productivity growth in US industries

Abstract

Using firm-level Compustat data from 1971 to 2000, we report a substantial cross-industry variation of allocative efficiency in capital expenditure in the US economy. Industries with higher allocative efficiency are the ones with higher firm-level value-added growth heterogeneity, higher information transparency captured by firm-specific stock return volatility and faster long-run productivity growth. This finding is consistent with the idea of creative destruction, where a well-functioning market mechanism sharply distinguishes winners from losers and thus enhances economic growth in the long run. Allocative efficiency has a substantial economic significance and explains as much as 24.5% of the difference in long-run industry productivity growth.

Keywords:

• allocative efficiency
• capital expenditure
• stock return volatility
• productivity

JEL Classification:

• G14
• G15
• G31

Acknowledgements

We thank Boyan Jovanovic, Randall Morck, Jungsoo Park, Bernard Yeung and seminar participants at the American Economic Association, the Korea International Economic Association, Seoul National University, the Stern School of Business at NYU and the Western Economic Association for helpful comments. Chun and Kim gratefully acknowledge the financial support from the Sogang University Research Fund and the Research Settlement Fund for the new faculty of Seoul National University, respectively.

Notes

¹Intuitively speaking, if stock prices do not reflect private information on companies, all the stocks tend to move together reflecting common public information. Section III discusses more about this variable and its relationship with efficient capital allocation.

²We exclude financial industries (SIC 6000–6999).