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Life cycle, cost of capital, earnings persistence and stock returns
Paul Hribar, University of Iowa
Nir Yehuda, Cornell University
ABSTRACT. This paper investigates the effect of the firm’s life cycle stage on the main determinants of the earnings-returns relation. In particular, we examine how earnings persistence, profitability, cost of capital, and the pricing of earnings vary across life cycle stages. First, we show that the frequency of losses monotonically declines as the firm moves through its life cycle. Second, we find that the persistence of losses is maximized at the growth stage, while the persistence of profits is maximized at maturity. Third, we find that the cost of capital decreases monotonically across stages. Fourth, we allow potential mispricing to vary by life cycle stage, and find the earnings persistence is most overestimated at the growth stage. After controlling for all of these effects, we find that ERCs reflect the expected permanence of profits, which is highest at maturity and lowest at decline.
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