From retaliation to resilience: tracing the path of earnings stability in competitive markets
Authors: Park Jimi , Yoo Shijin , Noh Minyoung 
Published: November 2024

Purpose

The purpose of this paper is to develop a more comprehensive understanding of the consequences of retaliations and our evidence indicates that retaliations are beneficial for firms with supranormal earnings by making their higher earnings more persistent, but harmful for firms with subnormal earnings by slowing the recovery of their earnings.

Design/methodology/approach

This paper use annual Compustat files based on Fama-French 48 industry. The time-varying competitive reactions (CRs) for each firm are captured using quarterly rolling-window estimation across 41 windows with five years (i.e. 20 observations) in each window. This paper measure earnings persistence as the slope coefficient (ß1) from regressing future earnings on current earnings. The result remains qualitatively similar to the main findings when alternative measures of earnings persistence.

Findings

Abnormal earnings are expected to dissipate in the long run owing to competitive forces, but this paper show that more retaliatory CRs increase earnings persistence. This is good news for supranormal firms as they can sustain high profitability. However, it will be harder to revert subnormal earnings to the industry mean if such firms conduct more retaliatory CRs. This paper also show that these associations are stronger for less competitive industries.

Research limitations/implications

First, high earnings persistence per se would not be a major consideration in the firm’s strategic decisions but a natural by-product of such decisions spanning an extended period of operations. Second, though this paper focus on the period of 2004–2018 that includes the rebound after financial crisis in 2008, an extension of the observation period over a longer economic cycle would verify our results.

Practical implications

CRs are regarded as an evolving portfolio of dynamic marketing decisions and tools for strategic decisions in our study. It helps how firms manage competition over time to lengthen the superior performance. Also it helps the low-profitability firms attempting to improve profitability by showing nonretaliation may be a more appropriate strategy than retaliation.

Social implications

Firms in financial distress suffer from illiquidity, survival of firms is contingent on meeting their financial obligations, thus need for turnaround decisions. However, retaliations under financial distress can mitigate the effect of such turnaround decisions and thereby aggravate the situation.

Originality/value

Greater persistence extends the benefits of superior earnings, thus increasing the opportunities for value exploitation, but it may also restrict earnings recovery. This paper finds that the way that firms react within the competition explain the differences in earnings persistence. Although a large body of research has examined the static drivers (e.g. firm size and diversification) of the differential persistence of earnings, there has been little research on dynamic drivers that explicitly recognize the erosion process for earnings.