Firm efficiency and stock returns

In this paper, we investigate the role of firm efficiency in asset pricing using a sample of US publicly listed companies for the period 1988–2007. We employ non‐parametric data envelopment analysis (DEA) on various input/output combinations, focusing on sales and market value as output measures in the construction of the frontier technologies. Using these performance measures, we examine whether efficient firms perform differently from inefficient firms following standard financial analysis procedures. First, we employ performance attribution regressions, by forming portfolios based on efficiency scores and tracking the performance of the various portfolios over time. Second, we perform cross‐sectional/panel regressions to determine whether firm efficiency indeed has explanatory power for the cross‐section of stock returns. Our results suggest that firm efficiency plays an important role in asset pricing and that efficient firms significantly outperform inefficient firms even after controlling for known risk factors.