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Augmenting the Indicator of Source Of Competitive Advantage Using Text Analysis: An Application To Recession’s Impact On Firm Value

Source of Competitive Advantage (SCA) is a fundamental yet imperfectly measured firm quality. We enhance the dichotomous SCA indicator from McAlister et al. (2016; firms that disclose advertising are differentiators; those that do not are cost leaders) by text analyzing the language firms use in published financial reports. Highlighting the interpretive power of text analysis, the text augmented SCA indicator leads to more accurate SCA identification.  We test the validity of the new indicator by showing its reliability and convergent and discriminant validities. The new indicator shows SCA’s moderation of recession’s impact on firm value.  (Differentiators are hurt more than cost leaders when a recession hits, but after a recession, differentiators recover firm value faster than cost leaders.) A manager who can more accurately identify competitors’ SCAs, can more effectively choose competitors’ customers to target. (A differentiator would want to target differentiator competitors’ customers, not the highly price sensitive customers of cost leader competitors.)