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Firm size, book-to-market ratio and the macroeconomic environment: theory and test

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  • Charles Mossman
  • Sergiy Rakhmayil

Abstract

Many studies find that stock returns are related to firm size and the book-to-market ratio. This article provides a theoretical explanation for this phenomenon. We show that profit maximizing homogenous firms should converge to a stable long-run equilibrium in which firm's capital size and growth rates are shaped by the economic environment, and both influence stock returns. Our evidence shows firm convergence towards the optimum profitability size in a changing equilibrium. Firm characteristics reflect sensitivity to the macroeconomic environment. Our model and empirical tests demonstrate a linkage between this sensitivity and the relationship of returns to market value and book-to-market.

Suggested Citation

  • Charles Mossman & Sergiy Rakhmayil, 2011. "Firm size, book-to-market ratio and the macroeconomic environment: theory and test," Applied Economics, Taylor & Francis Journals, vol. 43(19), pages 2417-2431.
    • Handle: RePEc:taf:applec:v:43:y:2011:i:19:p:2417-2431
    DOI: 10.1080/00036840903196639
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    References listed on IDEAS

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