Equity Book-to-Market Ratios Above One and Macroeconomic Risk

60 Pages Posted: 8 Jan 2019 Last revised: 13 Oct 2021

See all articles by Mary E. Barth

Mary E. Barth

Stanford University - Graduate School of Business

Doron Israeli

IDC Herzliya - Arison School of Business; Nazarbayev University - Graduate School of Business; affiliation not provided to SSRN

Suhas A. Sridharan

Emory University - Goizueta Business School

Date Written: September 22, 2021

Abstract

Equity book-to-market ratios (BTM) should not exceed one if a firm’s return on equity exceeds its cost of capital or it employs conservative accounting. Yet, BTM is above one for many firms. We address whether BTM above one reflects macroeconomic risk, which could explain this apparent incongruity. We find BTM above one generates larger hedge returns than BTM below one, but HML—the BTM-based return prediction factor—does not explain the returns for BTM above one. We also find that hedge returns for BTM above one are concentrated in recession years and likely reflect risk rather than mispricing. In addition, we find BTM above one reflects potentially overstated equity book values, but only in non-recession years. In contrast, high BTM below one does not generate hedge returns and reflects potentially overstated equity book values in recession and non-recession years. Together, our findings reveal that BTM above one reflects macroeconomic risk, which means that BTM above one has implications for risk assessment, return prediction, and asset under-impairment identification. Our study calls into question using HML as a return prediction factor for BTM above one and using BTM as a generic measure of conservative accounting or as the key indicator of overstated asset book values.

Keywords: Book-to-market ratios; Conservatism; Macroeconomic Risk

JEL Classification: D84; G11; G14; M41

Suggested Citation

Barth, Mary E. and Israeli, Doron and Sridharan, Suhas A., Equity Book-to-Market Ratios Above One and Macroeconomic Risk (September 22, 2021). Available at SSRN: https://ssrn.com/abstract=3306503 or http://dx.doi.org/10.2139/ssrn.3306503

Mary E. Barth

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-9040 (Phone)
650-725-0468 (Fax)

Doron Israeli (Contact Author)

IDC Herzliya - Arison School of Business ( email )

P.O. Box 167
Herzliya, 46150
Israel
+972 9 952 7673 (Phone)

Nazarbayev University - Graduate School of Business ( email )

53 Kabanbay Batyra Avenue
Nur-Sultan, 010000
Kazakhstan

affiliation not provided to SSRN

Suhas A. Sridharan

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

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