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Penetrating the Book‐to‐Market Black Box: The R&D Effect
Author(s) -
Lev Baruch,
Sougiannis Theodore
Publication year - 1999
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/1468-5957.00262
Subject(s) - economics , stock market , financial economics , stock (firearms) , monetary economics , phenomenon , investment (military) , mechanical engineering , paleontology , physics , horse , quantum mechanics , politics , political science , law , engineering , biology
The book‐to‐market (BM) phenomenon – the positive association between BM and subsequent returns – looms large among capital market enigmas. Economic theory postulates that the difference between market and book values of companies reflects their future abnormal profits. We capture these abnormal profits for a large sample of science‐based companies by estimating the value of the off‐balance sheet investment generating those profits – the value of R&D capital – and show empirically: (i) Firms’ R&D capital is associated with their subsequent stock returns. (ii) For R&D intensive firms, this ‘R&D effect’ subsumes the ‘book‐to‐market effect.’ (iii) The association between R&D and subsequent returns appears to result from an extra‐market risk factor inherent in R&D, rather than from stock mispricing. We thus provide an explanation for the book‐to‐market phenomenon of R&D companies.