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Tangibility and investment irreversibility in asset pricing
Author(s) -
Docherty Paul,
Chan Howard,
Easton Steve
Publication year - 2010
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/j.1467-629x.2010.00348.x
Subject(s) - economics , capital asset pricing model , value premium , explanatory power , financial economics , nexus (standard) , investment (military) , equity (law) , argument (complex analysis) , monetary economics , philosophy , epistemology , politics , computer science , political science , law , embedded system , biochemistry , chemistry
Zhang (2005) and Cooper (2006) provide a theoretical risk‐based explanation for the value premium by suggesting a nexus between firms’ book‐to‐market ratio and investment irreversibility. They argue that unproductive physical capacity is costly in contracting conditions but provides growth opportunities during economic expansions, resulting in covariant risk between firms’ investment in tangible assets and market‐wide returns. This article uses the Australian accounting environment to empirically test this theory – a test that is not possible using US data. Consistent with the theoretical argument, tangibility is priced in equity returns, and augmenting the Fama and French three‐factor model with a tangibility factor increases model explanatory power.