Book-to-Market Equity, Distress Risk, and Stock Returns


  • John M. Griffin,

  • Michael L. Lemmon

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    • Griffin is an Assistant Professor of Finance at Arizona State University and visiting Assistant Professor at Yale, and Lemmon is an Associate Professor of Finance at the University of Utah. A portion of this research was conducted while Griffin was a Dice Visiting Scholar at the Ohio State University. A previous version of this paper was entitled, “Does Book-to-Market Equity Proxy for Distress Risk or Mispricing?” We thank Gurdip Bakshi, Hank Bessembinder, Jim Booth, Kent Daniel, Hemang Desai, Wayne Ferson, Mike Hertzel, Grant McQueen, Gordon Phillips, Sheridan Titman, Russ Wermers, and especially an anonymous referee and René Stulz (the editor) for helpful comments. We also thank seminar participants at Arizona State University, Southern Methodist University, the University of Maryland, and the 1999 WFA meetings for comments and Lalitha Naveen and Kelsey Wei for research assistance.


This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson's (1980) O-score, the difference in returns between high and low book-to market securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage.