Market Reactions to Tangible and Intangible Information

TLDR

The book‑to‑market effect is commonly interpreted as evidence of high expected returns for distressed firms with poor past performance. The authors challenge this conventional interpretation. They find that future stock returns are unrelated to past accounting performance but are strongly negatively linked to the intangible component of past returns, making the book‑to‑market ratio and a composite equity‑issuance measure effective proxies for forecasting returns.

Abstract

ABSTRACT The book‐to‐market effect is often interpreted as evidence of high expected returns on stocks of “distressed” firms with poor past performance. We dispute this interpretation. We find that while a stock's future return is unrelated to the firm's past accounting‐based performance, it is strongly negatively related to the “intangible” return, the component of its past return that is orthogonal to the firm's past performance. Indeed, the book‐to‐market ratio forecasts returns because it is a good proxy for the intangible return. Also, a composite equity issuance measure, which is related to intangible returns, independently forecasts returns.