The Role of Risk in Explaining Differences in Profitability

Abstract

This study examined the role of risk in explaining cross-sectional differences in the profitability of business units. Applying suggestions of financial theory, we disaggregated risk into two components—systematic and unsystematic—that are thought to have different effects on return. Drawing on the PIMS data base, we found each component of risk to have a substantial, significant, and different impact on return on investment (ROI). The research and strategy implications of the roles of risk are discussed.