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

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  • Baruch Lev
  • Theodore Sougiannis

Abstract

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.

Suggested Citation

  • 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, April.
    • Handle: RePEc:bla:jbfnac:v:26:y:1999:i:3-4:p:419-449
    DOI: 10.1111/1468-5957.00262
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    Cited by:

    1. Omar Alsinglawi & Mohammad Aladwan, 2018. "The Effect of Invisible Intangibles on Volatility of Stock Prices," Modern Applied Science, Canadian Center of Science and Education, vol. 12(11), pages 290-290, November.
    2. Zhang, Yeqing & Zhang, Xueyong, 2020. "Patent growth and the long-run performance of VC-backed IPOs," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 33-47.
    3. Gaëlle Lenormand & Lionel Touchais, 2008. "The Value Relevance Of Intangible Assets With Ifrs [La Pertinence Des Actifs Incorporels Avec Les Ifrs]," Post-Print hal-03125514, HAL.
    4. Maletic, M., 2020. "Essays on international finance and empirical asset pricing," Other publications TiSEM 5888b491-8c83-4628-9175-d, Tilburg University, School of Economics and Management.
    5. Xiang, Erwei & Gasbarro, Dominic & Cullen, Grant & Ruan, Wenjuan, 2020. "Does R&D expenditure volatility affect stock return?," Journal of Contemporary Accounting and Economics, Elsevier, vol. 16(3).
    6. Luca Di Simone & Barbara Petracci & Mariacristina Piva, 2022. "Economic Sustainability, Innovation, and the ESG Factors: An Empirical Investigation," Sustainability, MDPI, vol. 14(4), pages 1-16, February.
    7. Stoffman, Noah & Woeppel, Michael & Yavuz, M. Deniz, 2022. "Small innovators: No risk, No return," Journal of Accounting and Economics, Elsevier, vol. 74(1).
    8. Leung, Woon Sau & Evans, Kevin P. & Mazouz, Khelifa, 2020. "The R&D anomaly: Risk or mispricing?," Journal of Banking & Finance, Elsevier, vol. 115(C).

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