Equity Book‐to‐Market Ratios Above One and Recession Risk

Mary E. Barth, Doron Israeli and Suhas A. Sridharan

Journal of Business Finance & Accounting, 2025, vol. 52, issue 5, 2236-2261

Abstract: Accounting theory suggests that equity book‐to‐market ratios (BTM) should not exceed one if a firm's return on equity exceeds its cost of capital or if it employs conservative accounting. Yet, BTM is above one for many firms, particularly in recession years. Recession risk is the extent to which a firm's equity returns are more sensitive to market returns during recessions than at other times, which could result in BTM above one. Thus, we address whether recession risk helps explain this apparent incongruity. We find that BTM above one generates predictable returns and that these returns (i) are concentrated in recession years; (ii) are explained by a modified version of HML, the BTM‐based return explanation factor; and (iii) likely reflect risk rather than mispricing. We also find that returns of firms with BTM above one are more sensitive to expected market risk premiums during recessions. In addition, we find BTM above one reflects potentially overstated equity book values, but only in nonrecession years. In contrast, high BTM below one does not generate predictable returns and reflects potentially overstated equity book values in recession and nonrecession years. Together, our findings reveal that recession risk helps explain BTM above one, which means that BTM above one has implications for risk assessment, return prediction, and asset underimpairment identification. Our study calls into question using HML as a return explanation factor for BTM above one and using BTM as a generic measure of conservative accounting or as the key indicator of overstated asset book values.

Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
https://doi.org/10.1111/jbfa.12873

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:jbfnac:v:52:y:2025:i:5:p:2236-2261

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0306-686X

Access Statistics for this article

Journal of Business Finance & Accounting is currently edited by P. F. Pope, A. W. Stark and M. Walker

More articles in Journal of Business Finance & Accounting from Wiley Blackwell
Bibliographic data for series maintained by Wiley Content Delivery ().