Risk Diversity Across Restaurants

This study examines how firm-specific financial characteristics affect the risk (i.e., from an investment-attractiveness perspective) of restaurants by examining the relationships among various firm-specific financial characteristics. The study considers the systematic and total risk of 52 restaurants from 1992 to 1995. The model used explains about half of the risk diversity across firms. The results of this analysis suggest that liquidity, dividend-payout ratio, return on assets, and growth in earnings before interest and taxes are important in explaining variation in risk across firms. In contrast, leverage seems to have little influence on market-based measures of risk. In general, high risk is likely to have an adverse effect on the cost of capital and can mean a high probability of insolvency. Though adequate liquidity is necessary for solvency, too much liquidity may suggest that available resources are not being invested in operating assets, which typically generate higher returns than cash or marketable securities. Firms with low payout ratios exhibit high risk, as low payout ratios may result in a high level of uncommitted internally generated funds. Managers ought to pay out earnings that cannot be profitably invested in the restaurants' operations. High operating returns are associated with low risk and tend to increase shareholder value. Aggressive and rapid growth, however, could increase risk by straining a firm's human resources and its ability to develop efficient controls and an effective internal structure.