Working Paper: NBER ID: w20880
Authors: Jia Chen; Kewei Hou; Ren M. Stulz
Abstract: Using theories from the behavioral finance literature to predict that investors are attracted to industries with more salient outcomes and that therefore firms in such industries have higher valuations, we find that firms in industries that have high industry-level dispersion of profitability have on average higher market-to-book ratios than firms in low dispersion industries. This positive relation between market-to-book ratios and industry profitability dispersion is economically large and statistically significant and is robust to controlling for variables used to explain firm-level valuation ratios in the literature. Consistent with the mispricing explanation of this finding, we show that firms in less boring industries have a lower implied cost of equity and lower realized returns. We explore alternative explanations for our finding, but find that these alternative explanations cannot explain our results.
Keywords: Behavioral Finance; Firm Valuation; Profitability Dispersion
JEL Codes: G12; G14; G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Industry Profitability Dispersion (L25) | Market-to-Book Ratios (G32) |
| Industry Profitability Dispersion (L25) | Realized Returns (G19) |
| Industry Profitability Dispersion (L25) | Ex Ante Discount Rates (E43) |
| Industry Profitability Dispersion (L25) | Mispricing Proxies (G19) |