Growth options and firm valuation

Holger Kraft, Eduardo Schwartz and Farina Weiss

European Financial Management, 2018, vol. 24, issue 2, 209-238

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.

Date: 2018
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