Growth options and firm valuation

Arbeitspapier

This paper studies the relation between firm value and a firm's growth options. We find strong empirical evidence that (average) Tobin's Q increases with firm-level volatility. The significance mainly comes from R&D firms, which have more growth options than non-R&D firms. By decomposing firm-level volatility into its systematic and unsystematic part, we document that only idiosyncratic volatility has a significant effect on valuation. Second, we analyze the relation of stock returns to realized contemporaneous idiosyncratic volatility and R&D expenses. Single sorting on idiosyncratic volatility yields a significant negative relation between portfolio alphas and contemporaneous idiosyncratic volatility for non-R&D portfolios, whereas in a four-factor model the portfolio alphas of R&D portfolios are all positive. Double sorting on idiosyncratic volatility and R&D expenses also reveals these differences between R&D and non-R&D firms. To control for several explanatory variables simultaneously, we also run panel regressions of firm-level alphas which confirm the relative importance of idiosyncratic volatility that is amplified by R&D expenses. Finally, we show that our results are robust to the definition of idiosyncratic volatility. We tease out the ``true'' idiosyncratic volatilities by performing a principal-component analysis on the residuals of Fama-French regressions and find that our main results still hold for this alternative definition of idiosyncratic volatility.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: SAFE Working Paper ; No. 6

Classification and Topics

• Classification: Wirtschaft ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: Firm valuation ; Real options ; Volatility ; R&D expenses ; PCA

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Kraft, Holger ; Schwartz, Eduardo S. ; Weiss, Farina
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, SAFE - Sustainable Architecture for Finance in Europe
• (where): Frankfurt a. M.
• (when): 2017

Further information

• DOI: doi:10.2139/ssrn.2224014
• Handle: http://hdl.handle.net/10419/203264
• Last update: 10.03.2025, 11:41 AM CET