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Penetrating the Book-to-Market Black Box: The R&D Effect

  • Baruch Lev

    (New York University, USA,)

  • Theodore Sougiannis
Registered author(s):

    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. Copyright Blackwell Publishers Ltd 1999.

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    Article provided by Wiley Blackwell in its journal Journal of Business Finance & Accounting.

    Volume (Year): 26 (1999-04)
    Issue (Month): 3-4 ()
    Pages: 419-449

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    Handle: RePEc:bla:jbfnac:v:26:y:1999-04:i:3-4:p:419-449
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