Competition Network, Distress Propagation, and Stock Returns

76 Pages Posted: 19 Nov 2020 Last revised: 20 May 2021

See all articles by MingMing Ao

MingMing Ao

San Diego State University

Winston Dou

The Wharton School, University of Pennsylvania

Shane A. Johnson

Texas A&M University - Department of Finance

Wei Wu

Texas A&M University

Date Written: May 18, 2021

Abstract

We build a competition network that links two industries through their common market leaders. Industries with higher centrality on the competition network have higher expected stock returns because of higher exposure to the cross-industry spillover of distress shocks. The competition intensity on the network is endogenously determined by the major players' economic and financial distress. We examine the core mechanism — the causal effects of firms' distress risk on their product market behavior and the propagation of these firm-specific distress shocks through the competition network — by exploiting the occurrence of local natural disasters and enforcement actions against financial frauds to identify idiosyncratic distress shocks. Firms hit by natural disasters or enforcement actions exhibit increased distress, then compete more aggressively by cutting profit margins. In response, their industry peers also cut profit margins, then become more distressed, especially in industries with high entry barriers. Crucially, distress shocks can propagate to other industries through common market leaders operating in multiple industries. These results cannot be explained by demand commonality or other network externality.

Keywords: Competition centrality, Economic/financial distress, Industry excess returns, Contagion, Natural disasters, Tacit collusion, Treatment externality.

JEL Classification: G32, G33, L11, L14

Suggested Citation

Ao, MingMing and Dou, Winston and Johnson, Shane A. and Wu, Wei, Competition Network, Distress Propagation, and Stock Returns (May 18, 2021). Available at SSRN: https://ssrn.com/abstract=3725236 or http://dx.doi.org/10.2139/ssrn.3725236

MingMing Ao

San Diego State University ( email )

5500 Campanile Dr,
San Diego, CA CA 92182
United States

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Shane A. Johnson

Texas A&M University - Department of Finance ( email )

Mays School of Business
College Station, TX 77843-4218
United States
979-862-3318 (Phone)

Wei Wu

Texas A&M University ( email )

360M Wehner
College Station, TX 77843-4218
United States
979-862-8092 (Phone)

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