Equity Book Values Greater Than Market Values: Accounting, Risk, or Mispricing?
54 Pages Posted: 8 Jan 2019 Last revised: 25 Aug 2019
Date Written: August 23, 2019
Despite accounting conservatism and indicating the firm’s required return exceeds its return on equity, equity book values greater than market values (BTM > 1) are not rare. The question we address is why. We find BTM > 1 is pervasive and persistent. More importantly, BTM > 1 is not attributable to overstated book values, which calls into question BTM as measuring conservative accounting for such firms. We find BTM > 1 is attributable to low equity market values, which partially stem from macroeconomic risk and other risk that differs for firms with BTM > 1. These findings call into question the use of Fama and French’s HML factor to reflect risk for firms with BTM > 1. Mispricing associated with investors over-extrapolating weakening in otherwise strong fundamentals contributes to the low equity market values. Together, our findings reveal the BTM threshold of one has meaningful implications for accounting and finance.
Keywords: Book-to-Market Ratios; Conservatism; Macroeconomic Risk; Extrapolation
JEL Classification: D84; G11; G14; M41
Suggested Citation: Suggested Citation