Capital to Labor Growth Ratio and the Cross-Section of Stock Returns

We examine the cross-sectional relation between the ratio of log growth in physical capital to log growth in labor and subsequent stock returns. The ratio is a negative predictor of abnormal returns and the relation strengthens with measures of financing constraint while remaining robust to previously provided determinants of returns. A ratio-based 2-factor model outperforms common asset pricing models explaining various anomalies indicating that anomalies reflect cross-sectional variation in growth ratio. We interpret the findings as outcomes reflecting displacements on the production isoquant, and show the pattern in returns is consistent with an investment-based model in which firms face financing constraints