Negative Tangible Equity

54 Pages Posted: 4 Aug 2021 Last revised: 1 Apr 2022

See all articles by Sanjeev Bhojraj

Sanjeev Bhojraj

Cornell University - Samuel Curtis Johnson Graduate School of Management

Bin Li

University of Houston - Bauer College of Business

Shivaram Rajgopal

Columbia University - Columbia Business School, Accounting, Business Law & Taxation

Date Written: 2021

Abstract

About 40% of the S&P 500 firms reported negative tangible equity (NTE) in 2019, a significant increase from the 10% level two decades ago. We find that debt-fueled NTE firms are associated with larger market caps with more stock buybacks and acquisitions of intangibles. NTE firms’ higher credit ratings and lower bond yields in the latest decade suggest that they are viewed as less risky by debtholders than in previous decades. We also find that their stock prices increase (decrease) immediately after the Federal Reserve’s monetary policy action decreased (increased) interest rates. In addition, NTE firms’ stock returns outperform by 4.72% and 4.85% in the first and the second year after portfolio formation in 2011–2019, but this better stock performance is not accompanied by higher earnings expectations. Our results contradict Graham and Dodd’s (1940) advice to avoid NTE firms but raise questions about their valuations, should interest rates rise in the future.

Suggested Citation

Bhojraj, Sanjeev and Li, Bin and Rajgopal, Shivaram, Negative Tangible Equity (2021). Available at SSRN: https://ssrn.com/abstract=3883467 or http://dx.doi.org/10.2139/ssrn.3883467

Sanjeev Bhojraj

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Accounting
Ithaca, NY 14853
United States
607-255-4069 (Phone)
607-254-4590 (Fax)

Bin Li (Contact Author)

University of Houston - Bauer College of Business ( email )

Bauer College of Business
4800 Calhoun Road
Houston, TX 77204
United States

Shivaram Rajgopal

Columbia University - Columbia Business School, Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

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