Risk, uncertainty & profitability : An accounting-based study of industrial firms' financial performance

Sammanfattning: It is often said, among practicians and theorists, that doing business is about taking risks. Thisthesis is focused on the relationship between doing business, and thereby earning a return, andthe inherent risk taking. A profitability risk perspective of the firm is taken, for which anappropriate theory and an accounting-based research methodology is developed.The empirical part of the thesis deals with the financial performance of Swedishindustrial firms. In particular, it is focused on profitability and its stability over time. Severalhypotheses concerning risk and return are specified and then tested in a large quantitativestudy involving 123 industrial firms investigated over the period 1982-96. According toeconomic theory, there is a positive relationship between risk and return. Thus whencontrolling for risk no firm can achieve an abnormally high return in the long run. Theempirical results stand in contrast with several of the stated hypotheses.The main conclusion from the empirical study is that firms earning a high return alsoearn a more stable return over time, whereas firms earning a low return have a more volatilereturn over time. If stability in return is a valid measure of risk, then the results are in conflictwith economic theory. Others have labelled similar findings a "risk-return paradox".Several other associations between financial variables have been investigated. Some ofthe results confirm hypotheses concerning risk, others do not. It seems as if the volatility inprofitability is mostly explained by operating risk, and then particularly the volatility in sales.But it is shown that the sensitivity to sales volatility also has an important role in explainingoperating risk. Furthermore, components of operating and financial risk are related to eachother, indicating that management has some ability to influence the level of risk.To explain a negative association between risk and return, the author returns to thedistinction between risk and uncertainty. It is argued that product markets are not as efficientas, e.g., financial markets. The conditions underlying a positive risk-return relationship are notfulfilled. Other explanations of the paradox could be misspecifications of risk, or non-linearrisk-return relationships. Without efficient markets, there can never be a positive risk-returnrelationship and it is questionable whether the efficiency of product markets will ever be adequate for a positive risk-return relationship to be achieved.