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Tangibility and investment irreversibility in asset pricing


  • The financial assistance provided by ARC Linkage grant (LP0560381) is gratefully acknowledged. We wish to thank seminar participants at the Universities of Melbourne and Newcastle. We also wish to thank Phil Gharghori, Jonathan Dark and the anonymous referees for constructive comments that have significantly improved the article.


Zhang (2005) and Cooper (2006) provide a theoretical risk-based explanation for the value premium by suggesting a nexus between firms’ book-to-market ratio and investment irreversibility. They argue that unproductive physical capacity is costly in contracting conditions but provides growth opportunities during economic expansions, resulting in covariant risk between firms’ investment in tangible assets and market-wide returns. This article uses the Australian accounting environment to empirically test this theory – a test that is not possible using US data. Consistent with the theoretical argument, tangibility is priced in equity returns, and augmenting the Fama and French three-factor model with a tangibility factor increases model explanatory power.