Product Market Competition and Industry Returns

Abstract

This paper studies how expected returns interact with product market competition. The model predicts that (i) competition erodes markups, such that firms are more exposed to systematic risk; (ii) the threat of entry by new firms lowers exposure to systematic risk of incumbents; and (iii) higher industry aggregate risk represents a barrier to entry, such that riskier industries become less competitive. We provide empirical evidence consistent with these three channels and for an overall negative relation between returns and competition. We also consider a sample selection correction for publicly listed firms and use it to construct an alternative concentration measure.