Publication Type

Journal Article

Version

acceptedVersion

Publication Date

3-2018

Abstract

Theory suggests that firm value should include the value of real options; that is, firms have the option to expand more profitable businesses and liquidate less profitable businesses. In a diversified firm, each segment has its own real options. Applying real options theory to a diversified firm at the firm level neglects the value of segment-level options. If investors overlook segment-level options, mispricing will occur. Using data from 1981 to 2013, we find that a hedge portfolio buying diversified firms in the highest decile of the estimated real option value of segments (RVS) and selling those in the lowest RVS decile earns a significant 0.79% size-adjusted monthly return. The hedge returns are more significant for firms whose growth opportunities mainly lie in the more profitable segments. We also find that the predictive power of RVS is stronger for firms with high growth, lower analyst coverage, and stronger corporate governance. Further investigation links improved operating performance to the exercise of segment-level real options.

Keywords

Real option value, Return predictability, Abnormal returns, Segment

Discipline

Accounting | Corporate Finance

Research Areas

Corporate Reporting and Disclosure

Publication

Review of Accounting Studies

Volume

23

Issue

1

First Page

167

Last Page

199

ISSN

1380-6653

Identifier

10.1007/s11142-017-9421-3

Publisher

Springer Verlag (Germany)

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1007/s11142-017-9421-3

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