The Asset Growth Anomaly and the Role of Limits to Arbitrage
49 Pages Posted: 11 Feb 2009 Last revised: 17 Sep 2017
Date Written: January 1, 2009
Several studies have documented that companies that increase capital investments or grow their total assets subsequently earn substantially lower risk-adjusted returns. While some studies attribute this phenomenon to investors' initial underreactions to overinvestments pursued by managers who are empire building, others attribute it to investors' initial overreactions to shifts in future business prospects implied by asset expansions. This paper examines the role of the limits to arbitrage in the negative effect of capital investment or asset growth on subsequent stock returns. We hypothesize that if the negative effect is due to investors' initial mis-reactions, the effect should be more pronounced when there are more severe limits to arbitrage. Our empirical evidence appears to support our hypothesis.
Keywords: Asset growth, Capital investment, Limits to arbitrage
JEL Classification: G14, G31, M41, M42
Suggested Citation: Suggested Citation