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Growth Options and Firm Valuation

Source:
forthcoming in European Financial Management
Year:
2017
Authors:
Holger Kraft,
Eduardo S. Schwartz,
Farina Weiss
Reseach Area:
Financial Markets
Abstract:

This paper studies the relationship between firm value and a firm's growth options. We find strong empirical evidence that 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. Sorting on idiosyncratic volatility yields a significant negative relationship between portfolio alphas and contemporaneous idiosyncratic volatility for non-R&D portfolios.

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