Market Perception of Firm Strategy

Porter (1980) and others (Hambrick, 1983, Kotha and Nair 1995) posit that firms pursuing either a cost leadership or a differentiation strategy are better able to gain competitive advantages over firms and accordingly achieve superior performance. Allen (2007) found that the lack of strategic emphasis, as defined by the generic strategies formulated in Porter (1980) to be the major reason for the downfall of several Japanese firms. In this paper, we investigate how capital markets perceive and reward the strategies pursued by firms. We find that markets place a high value on firms pursing either the cost leadership or the differentiation strategy. However the value placed on differentiation is higher than on cost leadership, highlighting the greater complexity of the differentiation strategy which would make replication of such a strategy difficult for competitors. Finally we show that firms that pursue higher levels of differentiation generate significant abnormal returns over the next three years.