Profitability, Risk and Market Structure in West German Industries

Abstract

IN a competitive environment rates of return on capital tend to be randomly distributed around some normal rate of opportunity cost of capital that includes a remuneration for risk bearing. Consequently, profits persistently exceeding a normal level can, at least partly, be accounted for by market power of either sellers or buyers or both. Empirical studies of these relationships for West German industries have conspicuously been absent so far. In order to begin filling this gap we shall report the results of a study explaining the mean rates of return of the period from I965 to I973 in a large sample of West German joint stock companies by risk and market structure. Besides risk, explanatory variables are the national degree of three-firm concentration, the export and import ratios, absolute and relative firm size, the rate of growth of sales of the individual firm, and finally the degree of product differentiation. The foreign trade ratios have been included as explanatory variables since in an open economy the relevant market obviously extends the national boundaries. Unfortunately, there is so far no single comprehensive theory available accounting for the relationships between rates of return, risk and market structure. Various models have been put forward each being concerned with a specific partial relationship. They guided the selection of our explanatory variables. Further inspiration came from empirical studies of industries in the US and other countries (see Weiss [I4], Bobel [i]).