Tangibility and Investment Irreversibility in Asset Pricing
31 Pages Posted: 22 Aug 2009 Last revised: 1 Feb 2010
Date Written: August 20, 2009
Zhang (2005) and Cooper (2006) provide a theoretical risk-based explanation for the value premium by suggesting a nexus between firms’ book-to-market ratio and investment irreversibility. They argue that unproductive physical capacity is costly in contracting conditions, but provides growth opportunities during economic expansions, resulting in covariant risk between firms’ investment in tangible assets and market-wide returns.
This paper uses the Australian accounting environment to empirically test this theory – a test that is not possible using US data. Consistent with the theoretical argument, tangibility is priced in equity returns, and augmenting the Fama and French three-factor model with a tangibility factor increases model explanatory power.
Keywords: Asset pricing, tangibility of assets, investment irreversibility, Fama-French model
JEL Classification: G12, G14
Suggested Citation: Suggested Citation