The Book-to-Price Effect in Stock Returns: Accounting for Leverage

Authors: PENMAN, STEPHEN H.¹; RICHARDSON, SCOTT A.²; TUNA, İREM²

Source: Journal of Accounting Research, Volume 45, Number 2, May 2007 , pp. 427-467(41)

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Abstract:

This paper lays out a decomposition of book-to-price (B/P) that derives from the accounting for book value and that articulates precisely how B/P “absorbs” leverage. The B/P ratio can be decomposed into an enterprise book-to-price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book-to-price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book-to-price, the leverage component of B/P is negatively associated with future stock returns. Further, both enterprise book-to-price and leverage explain returns over those associated with Fama and French nominated factors—including the book-to-price factor—albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk.

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1475-679X.2007.00240.x

Affiliations: 1: Department of Accounting, Columbia University 2: The Wharton School, University of Pennsylvania.

Publication date: 2007-05-01