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The Importance of Catering Incentives: Growth or Profitability?
Denys Glushkov,
Wharton Research Data Services University Of Pennsylvania
ABSTRACT. This paper tests a catering theory proposed by Aghion and Stein (2006) which predicts that managers concerned about the stock price may deviate from the first-best policy in setting profitability and revenue growth targets due to incentives to cater to the investor demand for firms with different composition between revenue growth and profit margins. After developing a “revenue growth premium”, I document three main results consistent with the catering theory: 1) periods when the premium is high tend to be followed by “higher-than-expected” growth indicators; 2) catering to the premium is more pronounced at firms where CEOs are more "incentivized";3) trading strategy based on longing firms with high margin surprises and shorting stocks with low margin surprises when the premium is high yields 5% annually after adjusting for risk and PEAD. The alternative that the market reactions to sales news contain useful information about future cash flows can't fully explain results.
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