Return Predictability along the Supply Chain: The International Evidence

Husayn Shahrur, Ying L. Becker and Didier Rosenfeld

Financial Analysts Journal, 2010, vol. 66, issue 3, 60-77

Abstract: In this study of a sample of equities listed on the exchanges of 22 developed countries, equity returns of customer industries led the returns of supplier industries. This customer–supplier/lead–lag effect exhibits characteristics consistent with the view that the effect results from a slow diffusion of value-relevant information.Recent research in finance has suggested that investors’ inattention to information can result in the predictability of security returns. Previous researchers have argued that if investors have limited ability to gather and process all publicly available information, value-relevant information that is incorporated in the stock prices of customer companies may not be fully reflected in the stock prices of their suppliers. Using company-level data on U.S. customer–supplier relationships, they found support for this proposition: Lagged equity returns of customer companies are positively correlated with suppliers’ contemporaneous equity returns.This article contributes to this strand of literature by examining whether a customer–supplier/lead–lag effect exists in international equity markets. We used the U.S. IO accounts to identify customer industries for each supplier industry in a sample of companies from 22 developed markets for January 1995–July 2007. Using a four-factor model to estimate abnormal returns, we found that the stock returns of customer industries lead the returns of supplier industries. Ranking supplier industries in ascending order on the basis of the one-month lagged returns of customer industries, we found that an equally weighted portfolio that buys supplier industries with the highest lagged customer returns (top quintile) and sells short industries with the lowest customer returns (bottom quintile) yields an annual abnormal return of up to 15 percent.Next, we examined whether the lead–lag effect depends on the characteristics of supplier companies. First, we found that our results are not driven by very small and highly illiquid supplier companies. Second, we documented that the customer–supplier cross-predictability is stronger for smaller suppliers and is statistically insignificant for the largest suppliers. We also conducted cross-sectional analyses to examine whether the lead–lag effect is subsumed by other factors known to be correlated with contemporaneous returns. We found that lagged customer returns predict supplier returns after controlling for other known factors, such as the company’s and the industry’s lagged short- and long-term returns and size effect.We conducted additional tests to examine whether the lead–lag effect is attributable to the slow diffusion of information among economically linked companies. We found that the cross-predictability of equity returns is stronger when security analysts have more difficulty in assessing how suppliers will be affected by news about their customers. We also found that the customer–supplier/lead–lag effect is more pronounced for suppliers with stronger economic links with their customers.Overall, this study contributes to the literature by documenting customer–supplier return cross-predictability in international markets. By examining the cross-sectional variation in the customer–supplier/lead–lag effect, we found results consistent with the view that this effect is attributable to the slow diffusion of value-relevant information. On the methodological front, we showed that the U.S. input-output accounts can be used to capture industry-level customer–supplier relationships in other markets, which should be of particular interest to investment practitioners in global equity markets.

Date: 2010
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DOI: 10.2469/faj.v66.n3.8

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