Equity Book Values Greater Than Market Values: Accounting, Risk, or Mispricing?

Abstract

Despite accounting conservatism and indicating the firm’s required return exceeds its return on equity, equity book values greater than market values (BTM > 1) are not rare. The question we address is why. We find BTM > 1 is pervasive and persistent. More importantly, BTM > 1 is not attributable to overstated book values, which calls into question BTM as measuring conservative accounting for such firms. We find BTM > 1 is attributable to low equity market values, which partially stem from macroeconomic risk and other risk that differs for firms with BTM > 1. These findings call into question the use of Fama and French’s HML factor to reflect risk for firms with BTM > 1. Mispricing associated with investors over-extrapolating weakening in otherwise strong fundamentals contributes to the low equity market values. Together, our findings reveal the BTM threshold of one has meaningful implications for accounting and finance.