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Determinants of the length of time a firm’s book-to-market ratio is greater than one

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Abstract

This paper examines the factors associated with the length of time that a firm’s market value is below its book value. From 1990 to 2010, approximately 19 % of firm quarter observations have a market value below their book value, and 46 % experience a market value below its below book value for more than 1 year. I investigate firm characteristics—accounting aggressiveness, asset liquidity, debt covenants, and cash flows; firm actions—merger, liquidation or an internal adaptation of resources; and accounting rules and their association with the length of time a firm’s book-to-market (BTM) ratio is greater than one. This paper extends the research on the adaptation option and also brings to light the unusual sample of observations that persist with a BTM ratio greater than one.

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Notes

  1. To be consistent with Burgstahler and Dichev (1997), I use the term adaptation for internal redeployments of resources as well as external adaptations, which include sell-offs, spin-offs, divestitures, and liquidations.

  2. Although somewhat higher, this result is consistent with Danielson and Press’s (2003) finding that from 1992 to 2000, 13 % of all firms have a BTM ratio greater than one.

  3. For brevity, when I refer to asset overvaluation I include liability undervaluation as well.

  4. The subscript i indicates firm observation and t is time.

  5. A poisson regression is not appropriate due to the rigid condition in a poisson distribution that the conditional mean of the dependent variable is equal to its conditional variable (see Rock et al. 2001).

  6. Two other proxies for conservatism include the BTM ratio and asymmetric timeliness. The BTM raio, suggested by Ohlson (Ohlson 1995, also see Beaver and Ryan 2000), is rejected due to the potential mechanical relation between the BTM ratio and the dependent variable. The second, provided by Basu (1997), considers the relation between economic events and earnings, hypothesizing that negative returns have a stronger relation with earnings than positive returns. Ball and Shivakumar (2005) argue that asymmetric timeliness is a conditional measure of conservatism, but because the hypothesis compares total conservatism, a more aggregate measure is appropriate. Also, the asymmetric timeliness measure is not well suited for firm-specific tests.

  7. I have conducted an examination of all of the FASB standards from 1990 through 2010 and determined that the three selected standards predominate FASB’s attempt to enforce conservatism.

  8. Table 5, Panel D shows the regression results using all observations.

  9. Of the 1,616 observations from the financial and utility industries, 1,504 are financial. This large number of financial observations is surprising, given the regulatory environment of the industry, as well as the greater propensity for assets to be closer to fair market value. I encourage future research from those acquainted with the financial industry on this finding.

  10. A firm can have more than one observation with a BTM ratio greater than one in the sample. On average, a firm has 1.2 observations in the sample of 1,712.

  11. I assume unequal variances between the two groups. A test of variances easily rejects the null of equal variances between the two groups in almost all cases.

  12. This analysis treats all observations as time independent. However, if an observation has a string of months with a BTM greater than one that begins before a particular standard but ends after, then this assumption is violated. To ensure that this is not driving results, I perform the analysis allowing the indicator variables D106, D121, and D142, to vary with time. The results are of the same tenor with this change.

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Acknowledgments

I appreciate the helpful comments and suggestions from my dissertation committee, David Burgstahler, Jarrad Harford, and Terry Shevlin, as well as those from Long Chen, Bowe Hansen, Derek Oler, Shiva Rajgopal, D. Shores, and workshop participants at the University of Washington, the BYU Accounting Consortium, the University of Alberta, Texas Tech University, George Mason University, the 2009 Annual American Accounting Association Meeting, and the 2011 Virginia Accounting Research Conference, and from the anonymous reviewer. I am also grateful to Lew Thorson for his programming assistance.

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  1. Pamplin College of Business, Virginia Polytechnic Institute and State University, 3007 Pamplin Hall, Blacksburg, VA, 24061, USA

    Mitchell Oler

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Correspondence to Mitchell Oler.

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This paper is based on the author’s dissertation at the University of Washington.

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Oler, M. Determinants of the length of time a firm’s book-to-market ratio is greater than one. Rev Quant Finan Acc 45, 509–539 (2015). https://doi.org/10.1007/s11156-014-0445-5

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