Fundamental risk and profitability: Evidence from high-tech companies

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School of Business | Master's thesis
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GOAL The goal of the study is to investigate whether fundamental risk explains future profitability in high-tech firms. Finance theories suggest that there is a positive connection between risk and returns. However, it is also possible that high risk leads to financial distress which can result in lower future profitability. I expect to find a significant association between fundamental risk and future profitability. The direction of the association is hard to predict, as current evidence is mixed. SAMPLE The sample used in the empirical tests consists of 14 749 publicly listed high-tech firms from 81 countries. The data was collected from Thomson One Banker database and it covers the years 1990-2010. RESEARCH METHODS The main tests were done using binary logistic regression. The dependent variable was a dummy that receives the value 1 when return on assets is zero or larger and 0 otherwise. The independent variables measure profitability, general business risk and financial risk. Two kinds of models were constructed: Parsimonious and Comprehensive. The Parsimonious model uses a narrower selection of independent variables and does not use lagged data. The Comprehensive model uses a wider range of risk proxies. Robustness tests were done using both ordinal logistic regression and multinomial logistic regression. MAIN RESULTS The study found that there is a negative association between fundamental risk and future profitability. This implies that financial statement information is useful in explaining future profitability in high-tech firms. Interestingly, high risk seems to lead to lower future profitability, which is in contrast with the risk-return premise in finance. This connection is even stronger in IPO firms which are presumed to be riskier than seasoned firms. It is evident that a model with a few key figures has the 'maximum' explanatory power and the use of a more comprehensive model is not beneficial.
fundamental risk, profitability, high-tech firm, regression analysis
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