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Exploring an efficient investment regime: The case of SP100 companies

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  • Chang, Tsangyao
  • Kang, Shuchen
  • Chiang, Gengnan

Abstract

We explore whether there exists an efficient investment regime for a panel of SP100 companies over the period 1986-2007. We demonstrate that abnormal stock returns are related to corporate total assets growth rate (a proxy variable for exercising real investment options through contraction, abandonment or expansion), change in EPS (a proxy variable for the change in profitability after exercising investment options), and one-year lagged P/B ratio (a proxy variable for the value factor), conditional on one-year lagged market-to-book assets ratio (MBA ratio, a proxy variable for the level of investment opportunity). We utilize the panel smooth transition regression (PSTR) model to examine the threshold effect of one-year lagged MBA ratio on abnormal stock returns. We find that there exists an efficient investment regime between two threshold values of 0.4773 and 3.2728. Our results are robust to predict, approximately 74.42%, the movement direction of abnormal stock returns in year 2008. Therefore, the main contribution of this paper is that the CEOs of SP100 companies are able to exercise investment options to create value for their firms if their levels of the investment opportunity are in the efficient investment regime.

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Bibliographic Info

Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 19 (2010)
Issue (Month): 2 (March)
Pages: 134-139

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Handle: RePEc:eee:finana:v:19:y:2010:i:2:p:134-139

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Web page: http://www.elsevier.com/locate/inca/620166

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Keywords: Efficient investment regime Panel smooth transition regression model Abnormal stock returns Assets growth EPS P/B ratio MBA ratio;

References

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  1. Christopher W. Anderson & Luis Garcia-Feijão, 2006. "Empirical Evidence on Capital Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 171-194, 02.
  2. Hansen, Bruce E., 1999. "Threshold effects in non-dynamic panels: Estimation, testing, and inference," Journal of Econometrics, Elsevier, vol. 93(2), pages 345-368, December.
  3. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  4. González, Andrés & Teräsvirta, Timo & van Dijk, Dick, 2005. "Panel Smooth Transition Regression Models," Working Paper Series in Economics and Finance 604, Stockholm School of Economics.
  5. Michael J. Cooper & Huseyin Gulen & Michael J. Schill, 2008. "Asset Growth and the Cross-Section of Stock Returns," Journal of Finance, American Finance Association, vol. 63(4), pages 1609-1651, 08.
  6. Tim Adam & Vidhan K. Goyal, 2008. "The Investment Opportunity Set And Its Proxy Variables," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 31(1), pages 41-63.
  7. Tuomo Vuolteenaho, 2002. "What Drives Firm-Level Stock Returns?," Journal of Finance, American Finance Association, vol. 57(1), pages 233-264, 02.
  8. Chen, Peter & Zhang, Guochang, 2007. "How do accounting variables explain stock price movements? Theory and evidence," Journal of Accounting and Economics, Elsevier, vol. 43(2-3), pages 219-244, July.
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