IDEAS home Printed from https://ideas.repec.org/a/kap/rqfnac/v44y2015i2p243-267.html
   My bibliography  Save this article

Growth options, option exercise and firms’ systematic risk

Author

Listed:
  • Nicos Koussis
  • Michalis Makrominas

Abstract

We develop and empirically test a theoretical model which analyzes the impact of growth options, profitability, and operating and financial leverage on equity’s systematic risk. Conditioning on the relative magnitude of advertising expenditure to research and development (R&D) expenditure, we find that higher beta is associated with higher return volatility, lower book to market ratio, lower return on assets, higher operating and financial leverage, and larger market capitalization (Size). Conditioning on R&D intensity, we show that an increase in the moneyness of firm options, or the exercise of firm options (approximated by increases in capital expenditure, advertising expenditure or profitability) result in more significant decreases in beta. Dynamically estimated high-frequency betas appear to perform well in capturing variation in firm systematic risk associated with growth option factors. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Nicos Koussis & Michalis Makrominas, 2015. "Growth options, option exercise and firms’ systematic risk," Review of Quantitative Finance and Accounting, Springer, vol. 44(2), pages 243-267, February.
    • Handle: RePEc:kap:rqfnac:v:44:y:2015:i:2:p:243-267
    DOI: 10.1007/s11156-013-0405-5
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s11156-013-0405-5
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s11156-013-0405-5?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Joao Gomes & Leonid Kogan & Lu Zhang, 2003. "Equilibrium Cross Section of Returns," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 693-732, August.
    2. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    3. Hansen, Lars Peter & Richard, Scott F, 1987. "The Role of Conditioning Information in Deducing Testable," Econometrica, Econometric Society, vol. 55(3), pages 587-613, May.
    4. Dirk Hackbarth & Erwan Morellec, 2008. "Stock Returns in Mergers and Acquisitions," Journal of Finance, American Finance Association, vol. 63(3), pages 1213-1252, June.
    5. Wan-Jiun Paul Chiou & Alice C. Lee & Cheng-Few Lee, 2009. "Variation in Stock Return Risks: An International Comparison," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 12(02), pages 245-266.
    6. Lewellen, Jonathan & Nagel, Stefan, 2006. "The conditional CAPM does not explain asset-pricing anomalies," Journal of Financial Economics, Elsevier, vol. 82(2), pages 289-314, November.
    7. John M. Griffin & Michael L. Lemmon, 2002. "Book‐to‐Market Equity, Distress Risk, and Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2317-2336, October.
    8. Christopher W. Anderson & Luis Garcia‐Feijóo, 2006. "Empirical Evidence on Capital Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 171-194, February.
    9. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, February.
    10. Praveen Kumar & Sorin M. Sorescu & Rodney D. Boehme & Bartley R. Danielsen, 2008. "Estimation Risk, Information, and the Conditional CAPM: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 21(3), pages 1037-1075, May.
    11. Jonathan Ingersoll & Ivo Welch, 2007. "Portfolio Performance Manipulation and Manipulation-proof Performance Measures," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1503-1546, 2007 17.
    12. Antonio E. Bernardo & Bhagwan Chowdhry & Amit Goyal, 2007. "Growth Options, Beta, and the Cost of Capital," Financial Management, Financial Management Association International, vol. 36(2), pages 1-13, July.
    13. Ravi Jagannathan & Iwan Meier, 2002. "Do We Need CAPM for Capital Budgeting?," Financial Management, Financial Management Association, vol. 31(4), Winter.
    14. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    15. Baruch Lev & Theodore Sougiannis, 1999. "Penetrating the Book-to-Market Black Box: The R&D Effect," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 26(3-4), pages 419-449.
    16. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    17. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    18. Louis K. C. Chan & Josef Lakonishok & Theodore Sougiannis, 2001. "The Stock Market Valuation of Research and Development Expenditures," Journal of Finance, American Finance Association, vol. 56(6), pages 2431-2456, December.
    19. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    20. Mark Broadie & Mikhail Chernov & Michael Johannes, 2009. "Understanding Index Option Returns," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4493-4529, November.
    21. Jonathan B. Berk & Richard C. Green & Vasant Naik, 1999. "Optimal Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 54(5), pages 1553-1607, October.
    22. Robert Novy-Marx, 2011. "Operating Leverage," Review of Finance, European Finance Association, vol. 15(1), pages 103-134.
    23. Edwin J. Elton, 1999. "Presidential Address: Expected Return, Realized Return, and Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 54(4), pages 1199-1220, August.
    24. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    25. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, April.
    26. Allan C. Eberhart & William F. Maxwell & Akhtar R. Siddique, 2004. "An Examination of Long-Term Abnormal Stock Returns and Operating Performance Following R&D Increases," Journal of Finance, American Finance Association, vol. 59(2), pages 623-650, April.
    27. Ron Giammarino & Murray Carlson & Adlai Fisher, 2004. "Corporate Investment and Asset Price Dynamics: Implications for Post-SEO Performance," 2004 Meeting Papers 812, Society for Economic Dynamics.
    28. David Morelli, 2012. "Security returns, beta, size, and book-to-market equity: evidence from the Shanghai A-share market," Review of Quantitative Finance and Accounting, Springer, vol. 38(1), pages 47-60, January.
    29. Lev, Baruch & Sougiannis, Theodore, 1996. "The capitalization, amortization, and value-relevance of R&D," Journal of Accounting and Economics, Elsevier, vol. 21(1), pages 107-138, February.
    30. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    31. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, vol. 33(2), pages 603-616, May.
    32. Murray Carlson & Adlai Fisher & Ron Giammarino, 2004. "Corporate Investment and Asset Price Dynamics: Implications for the Cross-section of Returns," Journal of Finance, American Finance Association, vol. 59(6), pages 2577-2603, December.
    33. Joshua D. Coval & Tyler Shumway, 2001. "Expected Option Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 983-1009, June.
    34. Ilan Cooper, 2006. "Asset Pricing Implications of Nonconvex Adjustment Costs and Irreversibility of Investment," Journal of Finance, American Finance Association, vol. 61(1), pages 139-170, February.
    35. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Liu, Hao & Zhang, Hao & Gao, Ya-Chun & Chen, Xu-Dong, 2022. "Firm age and beta: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 77(C), pages 244-261.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Da, Zhi & Guo, Re-Jin & Jagannathan, Ravi, 2012. "CAPM for estimating the cost of equity capital: Interpreting the empirical evidence," Journal of Financial Economics, Elsevier, vol. 103(1), pages 204-220.
    2. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    3. Stefan Nagel, 2013. "Empirical Cross-Sectional Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 167-199, November.
    4. Liu, Hao & Gao, Ya-Chun, 2019. "The impact of corporate lifecycle on Fama–French three-factor model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 513(C), pages 390-398.
    5. Michalis Makrominas, 2017. "Recognized intangibles and the present value of growth options," Review of Quantitative Finance and Accounting, Springer, vol. 48(2), pages 311-329, February.
    6. van Dijk, Mathijs A., 2011. "Is size dead? A review of the size effect in equity returns," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3263-3274.
    7. De Moor, Lieven & Sercu, Piet, 2013. "The smallest firm effect: An international study," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 129-155.
    8. Bhamra, Harjoat S. & Shim, Kyung Hwan, 2017. "Stochastic idiosyncratic cash flow risk and real options: Implications for stock returns," Journal of Economic Theory, Elsevier, vol. 168(C), pages 400-431.
    9. Eero Pätäri & Timo Leivo, 2017. "A Closer Look At Value Premium: Literature Review And Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 79-168, February.
    10. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, November.
    11. Kyung Shim & Harjoat Bhamra, 2015. "Stochastic Idiosyncratic Operating Risk and Real Options: Implications for Stock Returns," 2015 Meeting Papers 1494, Society for Economic Dynamics.
    12. George, Thomas J. & Hwang, Chuan-Yang, 2010. "A resolution of the distress risk and leverage puzzles in the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 96(1), pages 56-79, April.
    13. Long Chen & Lu Zhang, 2007. "Neoclassical Factors," NBER Working Papers 13282, National Bureau of Economic Research, Inc.
    14. Urbański, Stanisław & Zarzecki, Dariusz, 2022. "The Fama-French model for estimating the cost of equity capital: The impact of real options of investment projects," Economic Systems, Elsevier, vol. 46(1).
    15. Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
    16. 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, August.
    17. Prombutr, Wikrom & Phengpis, Chanwit & Zhang, Ying, 2012. "What explains the investment growth anomaly?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2532-2542.
    18. Lu Zhang, 2017. "The Investment CAPM," European Financial Management, European Financial Management Association, vol. 23(4), pages 545-603, September.
    19. Ray Ball & Gil Sadka & Ayung Tseng, 2022. "Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk," Review of Accounting Studies, Springer, vol. 27(2), pages 607-646, June.
    20. Lin, Xiaoji, 2012. "Endogenous technological progress and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 103(2), pages 411-427.

    More about this item

    Keywords

    Beta; CAPM; Real options; R&D; Advertising; Capital expenditure; G31; G32;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:rqfnac:v:44:y:2015:i:2:p:243-267. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.