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Growth Options and Firm Valuation

  • Holger Kraft
  • Eduardo S. Schwartz
  • Farina Weiss
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    This paper studies the relation between firm value and a firm's growth options. We find strong empirical evidence that (average) Tobin's Q increases with firm-level volatility. However, the significance mainly comes from R&D firms, which have more growth options than non-R&D firms. By decomposing firm-level volatility into its systematic and unsystematic part, we also document that only idiosyncratic volatility has a significant effect on valuation. Second, we analyze the relation of stock returns to realized contemporaneous idiosyncratic volatility and R&D expenses. Single sorting on idiosyncratic volatility yields a significant negative relation between portfolio alphas and contemporaneous idiosyncratic volatility for non-R&D portfolios, whereas in a four-factor model the portfolio alphas of R&D portfolios are all positive. Double sorting on idiosyncratic volatility and R&D expenses also reveals these differences between R&D and non-R&D firms. To control for several explanatory variables simultaneously, we also run panel regressions of portfolio alphas which confirm the relative importance of idiosyncratic volatility that is amplified by R&D expenses.

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    File URL: http://www.nber.org/papers/w18836.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18836.

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    Date of creation: Feb 2013
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    Handle: RePEc:nbr:nberwo:18836
    Note: AP
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