Competition risk and stock returns: Indian evidence

Purpose This study examines the relationship between competition risk and stock returns in the Indian market by utilizing the Marginal Cost to Average Cost (MCAC) ratio, a firm-level competition measure introduced by Taussig (2021). The study investigates whether cost efficiency, driven by competitive pressures, influences stock performance. Design/methodology/approach The study employs portfolio-sorting techniques and Fama-MacBeth cross-sectional regressions to analyze the relationship between MCAC and future stock returns. Firms are sorted into decile portfolios based on MCAC, and their subsequent equal-weighted (EW) and value-weighted (VW) returns are assessed using CAPM, Fama-French three-factor and Carhart four-factor models. The robustness of findings is tested through dual sorting on market power and examining different firm sizes to determine whether the effect is driven by small stocks. Findings The results indicate that firms with lower MCAC (higher cost efficiency) earn higher future stock returns, while firms with higher MCAC (cost pressure and inefficiency) underperform. Additionally, the findings suggest that the MCAC effect is distinct from market power effects, as efficiency appears to drive the return premium rather than monopoly power. Practical implications The study highlights the importance of cost structure in investment decision-making, suggesting that investors can use MCAC as a screening metric to identify firms with superior cost efficiency and higher expected returns. Moreover, the findings emphasize that competitive markets do not necessarily lead to higher risk premiums, but instead reward firms that achieve operational efficiency under competition. Originality/value This study contributes to the literature by providing first empirical evidence from an emerging market (India) on the relationship between MCAC and stock returns. Unlike prior research that focuses on industry concentration as a competition measure, this study introduces a firm-level competition risk proxy and demonstrates that cost efficiency, rather than monopoly power, drives excess stock returns.