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The Book-to-Price Effect in Stock Returns: Accounting for Leverage

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  • STEPHEN H. PENMAN
  • SCOTT A. RICHARDSON
  • İREM TUNA

Abstract

ABSTRACT This paper lays out a decomposition of book-to-price (B/P) that derives from the accounting for book value and that articulates precisely how B/P "absorbs" leverage. The B/P ratio can be decomposed into an enterprise book-to-price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book-to-price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book-to-price, the leverage component of B/P is "negatively" associated with future stock returns. Further, both enterprise book-to-price and leverage explain returns over those associated with Fama and French nominated factors-including the book-to-price factor-albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2007.

Suggested Citation

  • STEPHEN H. PENMAN & SCOTT A. RICHARDSON & İREM TUNA, 2007. "The Book-to-Price Effect in Stock Returns: Accounting for Leverage," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 427-467, May.
  • Handle: RePEc:bla:joares:v:45:y:2007:i:2:p:427-467
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