A value premium without operating leverage |
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Authors: | Graeme Guthrie |
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Institution: | School of Economics and Finance, PO Box 600, Victoria University of Wellington, Wellington, New Zealand |
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Abstract: | The existing real options literature explains the value premium as a consequence of either operating leverage raising risk in low-demand states or industry-wide investment lowering risk in high-demand states. This paper presents a simple model in which a value premium arises solely from capacity constraints. Profit is more sensitive to demand shocks when there is excess capacity, and the book-to-market ratio is high, than when capacity constraints bind, and the book-to-market ratio is low. The option to adjust capacity weakens the value premium arising from assets in place, but does not eliminate it for a wide range of parameters. |
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