Industry structure, macroeconomic fundamentals and return on equity

Abstract

Purpose The purpose of this paper is to examine the impact of industry structure and macroeconomic indicators on return on equity (ROE) of listed financial services firms. Design/methodology/approach Herfindahl–Hirschman Index concentration scales were used to categorise industries into competitive, moderate and concentrated segments, while Arbitrage Pricing Model principles were used to capture the effect of macroeconomic fundamentals on ROE. Generalised method of moments estimator was used to model random effects which were supported by the Hausman test. Findings Findings suggest that the influence of macroeconomic fundamentals on ROE deteriorates as one moves from competitive to concentrated industries. ROE is volatile in concentrated markets and less volatile in competitive markets. Concentrated markets generally enjoy monopoly profits. Gross domestic product and interest rates have a positive impact on ROE, while inflation, unemployment and exchange rates have a negative effect. Originality/value This study highlights the need to apply appropriate business strategies and policies depending on the structure of the industry. Competitive advantage strategies may assist in sustaining profits of firms in competitive markets. Regulators need to be proactive and stress test the impact of a policy on industry performance before implementation because competitive and concentrated markets react differently to external shocks. Risk tolerant investors may invest in volatile markets such as Russia and South Africa, while risk-averse investors may prefer to invest in less volatile markets such as India and China.

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