Penetrating the Book-to-Market Black Box: The R&D Effect |
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Authors: | Baruch Lev,& Theodore Sougiannis |
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Affiliation: | New York University, USA,;Department of Accountancy, University of Illinois at Urbana-Champaign, USA |
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Abstract: | 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. |
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Keywords: | stock returns book-to-market effect R&D effect R&D accounting |
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