(Mis)valuation and Investment

Vojislav Maksimovic

, Gordon Phillips** and Liu Yang***

COMMENTS WELCOME
This Version: November 17, 2010
We investigate the relation between market (mis)valuation and the subsequent pro-
ductivity of rms and industries. We also examine whether mergers and capital expen-
ditures that take place in periods of high (mis)valuation predict higher or lower future
productivity of investing rms or acquired assets. We show that high Tobins q and also
high estimated misvaluation (using measures developed in the literature) are associated
with higher productivity in the future. Examining acquisitions across industries, we nd
that the productivity of targets plants increases after the acquisition. The increase is not
smaller when the acquirer has higher valuation or is from a relatively more overvalued
industry. Thus, while industry (mis)valuation predicts acquisitions, there is no evidence
that high valuation or high estimated misvaluation lead to inecient diversication or
a misallocation of investment.

University of Maryland, **University of Maryland and NBER, and ***UCLA. Maksimovic can be reached
at vmax@rhsmith.umd.edu. Phillips can be reached at gphillips@rhsmith.umd.edu. Liu Yang can be reached at
liu.yang@anderson.ucla.edu. This research was supported by the NSF. The research in this paper was conducted
while the authors were Special Sworn Status researchers of the U.S. Census Bureau at the Center for Economic
Studies. Research results and conclusions expressed are those of the authors and do not necessarily reect the views
of the Census Bureau. This paper has been screened to ensure that no condential data are revealed.
(Mis)valuation and Investment
ABSTRACT
We investigate the relation between market (mis)valuation and the subsequent pro-
ductivity of rms and industries. We also examine whether mergers and capital expen-
ditures that take place in periods of high (mis)valuation predict higher or lower future
productivity of investing rms or acquired assets. We show that high Tobins q and also
high estimated misvaluation (using measures developed in the literature) are associated
with higher productivity in the future. Examining acquisitions across industries, we nd
that the productivity of targets plants increases after the acquisition. The increase is not
smaller when the acquirer has higher valuation or is from a relatively more overvalued
industry. Thus, while industry (mis)valuation predicts acquisitions, there is no evidence
that high valuation or high estimated misvaluation lead to inecient diversication or
a misallocation of investment..
1 Introduction
With the recent debates about "irrational exuberance" and pricing bubbles in nancial markets, the
role of the stock market in inuencing corporate investment decisions has assumed important policy
implications. If markets are subject to mispricing, and if market signals drive corporate investment
and mergers, then there exists the potential for nancial markets to systematically divert scarce
resources to unproductive uses. Several studies have investigated the link between market valuations
and corporate decisions. These papers have identied two areas as being of greatest interest: the
eect of market valuation on investment and merger decisions. While we have a very well developed
theory of the link between valuation and investment in ecient capital markets, there is controversy
given potential misvaluation of rms in nancial markets about whether rms do, or even should,
take market signals into account in determining the amount of their capital investments.
Several researchers have argued that many acquisitions occur because bidding rms attempt to
take advantage of temporary valuation anomalies. These studies strongly suggest that such mergers
may result in misallocated resources. Shleifer and Vishny (2003) propose a story based on irrational
stock market. They argue that if market believes that acquirer can transfer its productivity to target,
overvalued rms can buy assets from other rms and get the combined rm valued upwards even if
there is no synergy in transaction. Using a rational model, Rhodes-Kropf and Vishwanathan (2004)
show that if errors in valuing potential takeover synergies is correlated with the overall valuation
error, then mergers are more likely to occur during valuation waves when synergies tend to be over
estimated.
In this paper we rst examine the relation between market valuation and the subsequent pro-
ductivity of rms and industries. We then investigate how valuations aect real decisions such as
capital expenditure and acquisitions. We use the existence of bond rating as a proxy for nancial
constraints and test whether nancially constrained rms exhibit higher valuation investment sen-
sitivity. We also investigate whether mergers and capital expenditures that take place in periods of
high valuation predict higher or lower future productivity of investing rms or acquired assets. We
analyze these questions using plant-level data from US Bureau of Census between 1972 and 2004.
This dataset allows us to track productivities of individual plants, facilitating direct benchmarking
of plant productivities within each manufacturing industry on an annual basis. It also tracks own-
1
ership changes from year to year, allowing us to test whether an acquirers valuation predicts the
productivity growth of acquired plants.
We use Tobins q as our valuation measure and employ two additional measures that capture the
deviation of valuation from the predicted level recently introduced by Pastor and Veronesi (2003)
and Rhodes-Kropf, Robinson and Vishwanathan (2005). In both papers, regressions are used to
estimate the predicted a rms value based on observable characteristics, and the dierence between
the actual value and the predicted level is referred to as "misvaluation." Since this measure captures
the portion in Tobins q that cannot be explained by current characteristics, and as we show later
can be driven by rational expectation rather than mispricing, in the rest of this paper we will refer to
it as unexplained valuation. Similar to Rhodes-Kropf, Robinson and Vishwanathan (2005), we also
decompose the total level of Tobins q and unexplained valuation into a time-series cross-sectional
component and a rm-specic component to separate industry valuation eect from rm valuation
eect. Given the potential complexity of determining the structural relations between valuation,
productivity and investment in the presence of potential adjustment costs and costs of nancing,
rather than specifying a structural model, our approach is to follow the literature and use reduced
form specications to explore rst order relations between these variables.
We nd that for US manufacturing rms, valuation measured by Tobins q predicts future
productivity measured by Total Factor Productivity (TFP), both at the rm and industry level.
This result is consistent with macro-evidence, obtained using dierent measures of productivity,
that stock market valuation predicts increases in productivity in Beaudry and Portier (2006). This
eect is stronger in industries with more public rms, bigger rms, and higher concentration ratios.
Since higher investment drives down the marginal product of capital, as a check, we test whether
the relation between Tobins q and TFP is stronger in industries with lower capital expenditure and
nd that, as expected, that it is.. These results sets up a benchmark, showing that market signals
convey positive information about future productivity and that the relations between them accord
with predictions.
Next, we use measures of unexplained valuation instead of Tobins q to predict productivity
and nd similar results. Firms with higher unexplained valuations have higher productivity going
forward. The result holds both at the industry level and at the rm level. They also hold when
we Tobins q and unexplained variation are used together to predict future productivity. These
ndings suggest that stock prices do convey relevant information about future productivity, and
that unexplained valuation, which has been interpreted as misvaluation in several previous studies,
2
does not have dierent eects than productivity.
Both Tobins q and measures of misvaluation similarly predict capital expenditure. Industries
with higher Tobins q and unexplained valuation have higher CAPEX and rms that are relatively
more valued than industry peers invest more. When we use the existence of bond rating as a proxy
for nancial constraints, we nd that nancially constrained rms exhibit higher valuation capital
expenditure sensitivity than constrained rms. This is consistent with ndings in Campello and
Graham (2007).
We next examine decisions to buy or sell assets related to valuation. Firms with higher rm-
specic valuation are more likely to buy assets, and they buy assets in their existing industries
when industry Tobins q or unexplained valuation is high, and diversify into other industries when
current industry Tobins q or unexplained valuation is low. On the other hand, sellers tend be rms
with lower rm-specic Tobins q or misvaluation, but in industries with high valuation. We also
nd that buyers have higher productivity while sellers have lower productivity.
More insight on how valuation drives acquisition decisions is provided by examining the outcomes
of acquisitions. The productivity of targets plants increases after the acquisition. The improvement
in productivity is not smaller when acquirers have higher unexplained valuation. On the other hand,
the productivity gain is bigger when acquirers are more productive in their home industry and when
the dierence in industry Tobins qs between the acquirers and targets industry is high. We nd
little evidence that dierences in the acquirers and targets industry valuation predict productivity
gains of the acquired plants. Thus, while industry valuation predicts acquisitions, there is no
evidence that it leads to inecient acquisitions. Examining a sample of diversifying acquisitions, we
nd that Tobins q and valuation decline in acquirers home industries after acquisitions, especially in
cases when acquirers home industry has higher valuation around the transaction. This is consistent
with our earlier ndings that rms use acquisitions to pursue better opportunities.
Our paper contributes to the literature on the relation between rational and irrational market
valuation and rms investment decisions. On one hand, managers may be better informed about
the investment opportunities of their own rms than are outside investors, and therefore can ignore
stock market movement as it provides no new knowledge. On the other hand, as pointed out in Dow
and Gordon (1997) and Subrahmanyam and Titman (1999), managers may rely on stock market as
a source of information and improve their investment decisions. In addition, managers can also take
advantage of market mispricing of their stock by issuing equity and investing proceeds (Fischer and
Merton (1984)). The empirical evidence of how valuation aects rms investment decisions is at
3
best mixed. Morck, Shleifer and Vishny(1990) nd that, although returns can predict investment,
the predictive power disappears once they control for fundamentals. Similarly, Blanchard, Rhee and
Summers(1993) nd that the stock market does not aect investment, conditional on fundamentals,
even though it changes the composition of external nance. Meanwhile, Baker, Stein and Wurgler
(2003) show a high sensitivity of investment to Tobins q for nancially constrained rms, concluding
that stock market mispricing leads these rms to issue equity and invest proceeds in marginal
projects. Using data around the 1990s tech bubble, Campello and Graham (2007) show that
constrained non-tech rms issued equity in response to apparent mispricing to invest, but no such
pattern is observed for unconstrained non-tech or tech rms. In addition, Gilchrist, Himmelberg,
and Huberman(2005) and Polk and Sapienza (2009) both nd that measures of mispricing matter
in investment-q regressions. In contrast, recent paper by Bakke and Whited (2010) nd that rms
with high levels of mispricing and large rms consider mispricing irrelevant for investment using
errors-in-variables estimators. Like these authors, we also nd a positive relation between CAPEX
and Tobins q. Unlike them, we also explore and nd a positive relation between Tobins q and
productivity.
Our work is also related to the recent work in nance on the eect of market misvaluation on
rms investment decisions. The existence of sentiment driven mispricing is investigated by Delong,
Shleifer, Summers, and Waldmann (1990), Shleifer and Summers (1990), and Baker and Wurgler
(2006). Stein (1996) and Baker, Stein and Wurgler (2003) discuss models of sentiment driven
investment. We show that, using measures suggested by Pastor and Veronesi (2003) and Rhodes-
Kropf, Robinson, and Vishwanathan (2005), misvaluation does indeed predict both CAPEX and
acquisitions, but importantly we also show that what is believed as misvaluation, like high Tobins
q, is associated with increases in productivity.
Recent work, in particular by Shleifer and Vishny (2003) and Rhodes-Kropf, Robinson, and
Vishwanathan (2005) has argued that merger activity is to a signicant extent driven by misval-
uation. One implication of this work is that a signicant fraction of mergers might result in the
misallocation of assets to acquirers who may not be able to operate them eciently. Like these
authors, we nd that conventional measures of misvaluation do predict merger activity. Somewhat
surprisingly, we do not nd misvaluation associated with adverse post-merger productivity changes.
The positive association between valuation and future productivity documented in our paper
suggests that deviation in valuation from past level may be driven by rational expectation on
future changes in industry or rm conditions, rather than reecting changes in investor sentiment
4
unmoored from rm and industry fundamentals. Due to market imperfections such as nancial
constraints or time to build, rms may not be able to expand their capacity immediately to respond
a positive shock. Expecting future improvement, valuation increases beyond a level that is predicted
by current rm characteristics, resulting a seemingly unjustiable misvaluation. In the meantime,
interpreting high unexplained valuation as a positive signal, its creditors and suppliers may exhibit
greater willingness to extend nancing to the rm which ultimately lead to ecient investment
and higher productivity. Ovtchinnikov and McConnell (2009) present numerical examples and
empirical tests supporting the view that in an imperfect but rational market high valuations relax
constraints, leading to increased investment that mimics the pattern that would be predicted by
irrational overvaluation. In addition, high unexplained valuation at the rm level can also convey
a positive signal of the rms prospects to competitors and consumers which may help the rm to
gain advantage on the product market. Alternatively, high unexplained valuation may just reect
unusually good prospects for the rm and industry, and thereby have no causal signicance. In all
three cases, measures of high unexplained valuation, like Tobins q, can be associated with increased
productivity.
The rest of the paper is organized as follows. Section 2 describes our empirical strategy and
measures of misvaluation. Section 3 discusses the data and the construction of our productivity
measure. Section 4, 5 and 6 presents our results on the relation between valuation and productivity,
capital expenditure and acquisition decisions, respectively. Section 7 concludes.
2 Methodology
We draw on the existing literature on valuation and investment to motivate our empirical tests.
Historically the literature on Tobins q and investment has examined regressions like the following:
1:c:t:c:t
i;t+1
= +,
1

it
+,
2
A
it
+
it
(1)
with additional terms added to this model to examine whether other factors such as protability,
cash holdings, or nancial constraints impact investment. Recently, the literature has moved to
include valuation relative to predicted valuation rather than Tobins q itself. For example, both
Rhodes-Kropf, Robinson, and Vishwanathan (2005) and Dong, Hirshleifer, Richardson, and Teoh
(2006) analyze how deviation from predicted valuation (or "misvaluation") aect mergers. Hoberg
and Phillips (2010) use deviation from predicted valuation to measure industry booms and examine
5
how real and nancial factors interact in business cycles. These articles construct estimates of
predicted valuation using dierent models and then compare the actual valuations to predicted
valuations to dene relative valuation (or misvaluation).
In this paper, we use Tobins q and deviations from the predicted valuation as our variables of
interest on the right hand side. We begin with a model based on Rhodes-Kropf, Robinson, and
Vishwanathan (2005) (model (3)). For each industry, we regress rm is log market value of equity
on its log book value of equity, net income, an indicator for negative net income and leverage ratio:
log (`
i;t
) = c
0
+c
1
log (1
it
) +c
2
log (`1
it
)
+
+c
3
1
<0
log (`1)
+
it
+c
4
11\
it
(2)
To avoid look-ahead basis, instead of using the whole time periods, we use a 10-year rolling window.
That is, we estimate the regression above using 10 years of lagged data and then use the estimated
industry-specic regression coecients to compute the predicted market value of equity assuming
that a rms market value at time t is a function of its current characteristics and the industry
specic value of characteristics estimated from past 10 years. The deviation is equal to actual
valuation less predicted market valuation:
l:crj|ci:cd \ c|nctio:
i;t
= |oq (`
i;t
)
i;t
1:cdictcd(log( `
i;t
)) (3)
We will refer to the above measure as l\
RKRV
.
We also follow Hoberg and Phillips (2010) and estimate a valuation model from Pastor and
Veronesi (2003) for each industry using lagged data. Similar to them, for each industry, we regress
the log of the market-to-book ratio, |oq(
M
B
). on minus the reciprocal of one plus rm age (AGE),
a dividend dummy (DD), rm leverage (LEV), the log of total assets (SIZE), current rm return
on equity (ROE), and the volatility of protability (VOLP) for each rm i:
|oq(
`
1
)
i;t
= c +/G1
i;t
+c11
i;t
+d11\
i;t
+c|oq(o121
i;t
) +,\ C11
i;t
+q1C1
i;t
. (4)
As in the previous measure and in Hoberg and Phillips (2010), for each industry, we use data from
the past 10 years to estimate the regression above, and use the estimated coecients to compute
predicted values for rm market-to-book in year t. It assumes that rm is market-to-book at time t
is a function of its current characteristics and the industry specic prices of characteristics estimated
from past years. A rms total relative valuation therefore is its actual |oq(
M
B
) less its predicted
6
|oq(
M
B
) for year t as follows:
l:crj|ci:cd \ c|nctio:
i;t
= |oq(
`
1
)
i;t
1:cdictcd( |oq(
`
1
)
i;t
) (5)
We refer to this measures of unexplained valuation as l\
PV
.
Although both Tobins q and UVs are aected by stock market movement, there is a subtle
dierence. For example, a rm with a high protability should be more valuable and hence have
a high Tobins q. If the relationship between protability and valuation remains constant, then all
the valuation can be explained by current protability, and UV will be equal to zero. In contrast, a
rm with low protability now but high growth potential may have a Tobins q that cannot be fully
explained by current protability, and therefore a positive UV. Because UVs are estimated using
historical information, it captures not only the current level but also how Tobins q has changed or
will change over time.
For all three measures (Tobins q, l\
RKRV
, and l\
PV
), we break the total valuation into an
industry component (computed as the weighted average using market capitalization of all rms in
that industry) and a component that is rm specic. The industry component captures changes
in industry overall valuation and the rm-specic component measures whether a rm is relatively
over- or under-valued compared to the predicted industry average.
3 Data
We use data from the Longitudinal Research Database (LRD) maintained by the Center for Eco-
nomic Studies (CES) at the Bureau of the Census to estimate total factor productivity and to
identify and track mergers and asset sales. The LRD tracks approximately 50,000 manufacturing
plants every year from the Annual Survey of Manufactures (ASM). It contains detailed plant-level
data on the value of shipments produced by each plant, investments broken down by equipment and
buildings, and the number of employees.
1
The ASM covers all plants with more than 250 employees.
Smaller plants are randomly selected every fth year to complete a rotating ve-year panel. Even
though it is called the Annual Survey of Manufactures, reporting is mandatory for large plants and
is mandatory for smaller plants once they are selected to participate. All data are reported to the
government by law and nes are levied for misreporting.
1
For a more detailed description of the Longitudinal Research Database (LRD) see McGuckin and Pascoe (1988)
and also Maksimovic and Phillips (2002).
7
The data we use covers the period from 1972 to 2004. To be included in our sample, rms
must have manufacturing operations in SIC codes 2000-3999. We require each plant to have a
minimum of three years of data. For each rm, we also exclude all its plants in an industry (at the
three-digit SIC code) if its total value of shipments in that industry is less than $1 million in real
1982 dollars. Since we construct measures of productivity (described later) using up to 5 years of
lagged data, our regressions cover the period between 1976 and 2004. Since we compute the rate of
capital expenditure by dividing capital expenditure on lagged capital stock and calculate change of
sales using lagged sales, we lose the initial year a rm or a rm-segment enters the database and
observations that are non-continuous. Our nal sample has about 520,000 rm-industry years and
more than 1 million plant years.
3.1 Productivity Measures
We estimate total factor productivity (TFP) using a translog production function. This functional
form is a second-degree approximation to any arbitrary production function, and therefore takes
into account interactions between inputs. Specically, for each industry, we estimate the following
model using an unbalanced panel with plant-level xed eects:
ln Q
it
= +,
i
+
N
X
j=1
c
j
ln 1
jit
+
N
X
j=1
N
X
k=j
c
jk
ln 1
jit
ln 1
kit;
+
it
(6)
where Q
it
represents output for plant i in year t and 1
ijt
is the quantity of input , used in production
for plant i for time period t. is the technology shift parameter, assumed to be constant by industry,
,
i
is a plant-rm specic xed eect,
2
and
it
is the residual term. The input factors included are
capital, labor, and material and energy costs.
We obtain our measure of plant-level TFP from adding two components from the equation (6)
above: a plant-rm xed eect, ,
i
, and a plant residual term
it
. The xed eect captures persistent
productivity eects, such as those arising from managerial quality (Griliches (1957) and Mundlak
(1978)), and a rms ability to price higher than the industry average. The residual term measures
the deviation of the actual output from the predicted output. The industry average TFP of a
given year is computed as the average of all plant-level TFPs in that year. We then decompose the
plant-level TFP into an industry-year component and a plant-specic component. The industry
component captures changes in productivity in the industry while the plant-specic component
2
If a plant changes owners, a new xed eect is estimated.
8
measures whether a plant is relatively more or less productive compared to the average plant in the
industry.
3.2 Data Summary
The aggregate TFP has been trending up in the past thirty years, especially during the 1990s.
Figure 1 presents the time series plot of TFP, Tobins q and unexplained valuation. The correlation
between our TFP series and the TFP series obtained from NBER-CES Manufacturing Productivity
Database is about 90% on the annual level.
3
Tobins q is positively related to l\
RKRV
and l\
PV
,
and the two UV measures have a correlation of 71%. During our sample period, there are two peaks
for UVs, one in the 80s (82-97), and the other one in the 90s (92-97).
[Insert Figure 1 Here]
4 Valuation and Productivity - The General Pattern
To examine how valuation in general aects productivity, we rst construct an industry year panel
(based on three-digit SIC). For each industry in a given year, we calculate the average TFP, Tobins
q, l\
RKRV
and l\
PV
. Then, we estimate an industry xed eect model using the following
specication:
111
i;t+1
= c
i
+/ \ c|nctio:
i;t
+c 111
i;t
If stock market captures changes in agents expectation about future economic conditions, then
a higher valuation will predict higher productivity going forward. We also include the lagged
productivity on the RHS because productivity has been shown to exhibit strong persistence over
time.
Table 1 Panel A shows the estimated coecients. Both Tobins q and UVs have positive signs
and are statistically signicant at 1% level. It is well documented that when lags of the dependent
variable are included as covariates, they may correlate with the unobserved panel-level eects and
therefore make standard estimators inconsistent. As a remedy, we use the GMM estimator derived
in Arellano and Bond (1991) as an alternative estimation and results are reported in Table 1 Panel
B. Adjusting for potential correlation between lagged dependent variable and panel-level eects
3
TFPs in the NBER-CES Manufacturing Productivity Database are computed using a dierent method based on
changes in output and input shares (http://www.nber.org/nberces/t0205.pdf).
9
makes the eect of valuation on productivity even stronger. The estimated coecient on Tobins
q or UV increases by more than 40%. One standard deviation increase in Tobins q leads to a
7.5% increase in TFP in the next period, and one standard deviation increase in l\
RKRV
or l\
PV
leads to an increase of TFP of 6.5% and 8.3%, respectively. When both Tobins q and UV are
included, the coecient on UV remains largely unchanged, but the coecient on Tobins q shrinks
signicantly, suggesting that changes in productivity is mainly predicted by the unexplained portion
of valuation.
In unreported regressions, we also use the TFP series obtained from the NBER-CES Manu-
facturing Productivity Database to run the same specication, but for a longer time series (from
1960-2005) and results are qualitatively the same. Our nding that valuation predicts future pro-
ductivity is consistent with the view that future changes in productivity are preceded by stock
market (Beaudry and Portier (2006)).
[INSERT TABLE 1 HERE]
If stock market movement signals changes in opportunities for the industry, does valuation
predict productivity for both public and private rms? To answer this question, we break industries
into two equally-sized categories based on the average percentage of public rms over our sample
period, and estimate the same specication using Arellano and Bond GMM estimator for both
categories. Table 2A reveals that most of the eect between valuation and productivity is driven
by high-public industries which also show stronger persistence in TFP. This is consistent with
Maksimovic, Phillips and Yang (2010) who suggest that public status is a reection of rm quality
and better rms choose to become public and later are more responsive to changes in investment
opportunities.
[INSERT TABLE 2 HERE]
Table 2 Panel B to D presents estimated coecients based on Arellano and Bond GMM estima-
tors using additional sample splits. Panel B separates all industries into two equally-sized categories
based on industry concentration ratio. We dene an industry to be concentrated (competitive) if
the average Herndhal index based on sales is greater(less) then sample median. Tobins q has a
bigger eect predicting productivity in competitive industries while both UV measures point to the
dierent direction. Since rms in concentrated industries have more bargaining power with suppli-
ers and enjoy more entry barrier, given the same industry-wide opportunity, they may be able to
better capture rents as compared to rms in competitive industries. We also nd that productivity
10
is more persistent in concentrated industries. This is consistent with ndings in Hoberg and Phillips
(2010) who show that cash ows are also more persistent in concentrated industries.
In Panel C, we compare the eect for small- and large-rm industries. We dene a rm to be
small if it has less than 50 employees
4
and break industries into equally-sized categories based on
average percentage of small rms over our sample. Valuation has a stronger predicting eect for
future productivity in large-rm industries.
Since higher investment drives down the marginal product of capital, as a check, we test whether
the relation between Tobins q and TFP is stronger in industries with lower capital expenditure.
We separate all industries based on the rate of capital expenditure over lagged assets into two
equally-size category, and nd that coecients on Tobins q and UVs are much bigger for low-capex
industries than for high-capex industries.
So far, we show that high valuation predicts high productivity at the industry level. Next, we
investigate the same relationship at the rm level. That is, when a rm is relatively overvalued
compared to its industry peers, does it predict relatively higher productivity in the future? For this
purpose, we estimate a rm xed-eect model as follows:

111
j;i;t+1
111
i;t+1

= c
i
+/

\ c|nctio:
j;i;t
\ c|nctio:
i;t

+c

111
j;i;t
111
i;t

where we take the industry factor away in both productivity and valuation and regress rm-specic
productivity of rm , in industry i at t + 1 on lagged rm-specic valuation and rm-specic
productivity. As in the industry level analysis, we use Arellano and Bond GMM estimator since the
unobserved rm xed eect may be correlated with lagged dependent variable. We exclude rms
with less than 10 years of data to have a reasonable panel for dierencing.
5
Due to data availability,
for this test, only public rms are included in the regression. Table 3 reports our ndings.
[INSERT TABLE 3 HERE]
Tobins q consistently predicts future productivity, individually or jointly with UV measures.
High l\
RKRV
also predicts high productivity in the future, but becomes marginally signicant
when we also include Tobins q. Meanwhile, we dont nd evidence that l\
PV
predicts future
productivity. One reason for the dierence observed between l\
RKRV
and l\
PV
can be due to the
dierence in the rst-stage estimation. To estimate l\
PV
, changes of valuation due to changes in
4
This is similar to the denition used by Small Business Association (http://www.sba.gov).
5
This is not crucial for our results and we obtain qualitatively the same results without exclusion.
11
risk has been ltered out by including the volatility of protability on the RHS (VOLP in (4)) while
the estimation of l\
RKRV
does not include similar measures. When valuation goes up corresponding
to a drop in volatility, the increase in valuation will show up in l\
RKRV
, but not in l\
PV
. As
volatility decreases, rms are more likely to make investment. If those investments lead to more
ecient capital(new equipment or structure), then productivity will rise in the future.
Firms may not be aected uniformly given changes in the industry. In Table 4, we regress the
rm-specic TFP on industry valuation, together with the interaction of industry valuation and
rm characteristics:

111
j;i;t+1
111
i;t+1

= c
i
+,
t
+/ \ c|nctio:
i;t
+c A
j;i;t
\ c|nctio:
i;t
where X
j;i;t
includes rm characteristics such as size and productivity, c
i
is the industry xed
eect and ,
t
captures year xed eect. If large and more productive rms are better positioned to
take advantages when opportunities rise in the industry, then we should observe higher growth in
productivity for those rms when industry valuation is high (i.e. c 0). On the other hand, if
growth opportunities give small and less productive rms bigger room to expand, then we should
observe growth in productivity negatively correlated with size and productivity when industry
valuation is high (i.e., c < 0). We nd that for Tobins q and UV
RKRV
, both interaction terms are
positive and statistically signicant at 1% level. Large and more productive rms experience higher
productivity growth when there is growth opportunity in the industry. Analyzing how changes in
industry valuation aect rm-specic productivity allows us to separate the level eect from the
re-distribution eect. Our nding suggests that large and more productive rms benet more when
industry experiences high valuation. We do not nd the same pattern when we use UV
PV
.
[INSERT TABLE 4 HERE]
5 Valuation and Capital Expenditure
If valuation is indeed capturing the growth opportunity of an industry, then we should observe
rms invest more when valuation is high. Table 5 examines the relationship between valuation and
capital expenditure on the industry level:
Ccjcr
i;t+1
= c
i
+,
t
+/ \ c|nctio:
i;t
+c A
it
12
The dependent variable is the average rate of capital expenditure in industry i at t+1. In addition to
the valuation measure which is our main focus, we also include other industry characteristics (A
it
)
for control purposes. For example, we use operating margin (opmarg) as a proxy for protability,
asset turnover rate (atturn) as a proxy for asset utilization, and include an dummy variable (d_econ)
to indicate the demand condition - it is equal to one if changes in shipment are negative in the
past two consecutive years, three if changes are positive in the past two consecutive years and two
otherwise. Other studies have suggested that rms with higher asset turnover ratio, more cash in
hand and positive demand are more likely to invest. All independent variables are lagged by one
year and we include year and industry xed eects in all specications.
[INSERT TABLE 5 HERE]
Capital expenditure is positively related to valuation, signicant at 1% level. Both Tobins q
and UVs predict future capital expenditure, separately or jointly. Industries with higher Tobins
q or UVs have higher capital expenditure, suggesting that rms invest more when productivity is
perceived to improve. In addition, we nd that capital expenditure is high when asset turnover rate
is high and when the industry is experiencing positive demand shocks.
Table 6 estimates the eect of valuation on capital expenditure on the rm level using the sub-
sample of public rms and nd similar results. To separate the industry eect from the rm eect,
for each valuation measure, we break it into an industry component and a rm-specic compo-
nent and then regress capital expenditure ration on lagged industry and rm valuation measures
controlling for other rm characteristics:
Ccjcr
j;i;t+1
= c
i
+,
t
+/ \ c|nctio:
i;t
+c

\ c|nctio:
j;i;t
\ c|nctio:
i;t

+c A
j;i;t
(7)
for rm , in industry i at time t +1. We also include year and industry eects (c
0
i
: and ,
0
t
:) in our
regression. Table 6 presents our ndings. Both industry and rm-specic valuation matter. Firms
invest more when industry valuation is high and when rm-specic valuation is high. Both Tobins
q and UVs are statistically signicant at 10% level, individually or jointly. In addition, we nd
that rms with higher productivity and higher protability also invest more. Capital expenditure
is also higher in rms main segment (as compared to peripheral segment)
6
and when demand is
high (increase in shipment). It is worth noting that in both industry and rm-level regressions,
the coecients on UV
RKRV
are consistently bigger than coecients on UV
PV
. Since UV
PV
has
6
We dene a segment to be main segment if the segment sales account for more than 25% of rms total sales.
13
ltered out changes in valuation due to changes in volatility while UV
RKRV
has not, it implies that
investments are higher when volatility decrease and therefore is consistent with our earlier ndings
that UV
RKRV
predicts future productivity at the rm level while UV
PV
does not.
In sum, we show using both industry and rm-level evidence that capital expenditure is related
to industry and rm valuation measures. Our nding here further supports the view that market
valuation reects changes in expectation on fundamentals and that rms make investment decisions
to take advantage of new opportunities.
[INSERT TABLE 6 HERE]
Afewpapers in the literature have documented that the eect of valuation on capital expenditure
is mainly driven by nancial constrained rms. Next, we test whether this pattern is also present
in our dataset. We use the existence of bond rating as a proxy for nancial constraint following
Kashyap, Stein and Wilcox (1993). Table 7 shows that although non-rated rms invest more when
valuation measures are high, our results from Table 6 remain hold for all rms. That is, rms on
average invest more when valuation measures (both industry and rm-specic) are high although
the valuation - capital expenditure sensitivity is bigger for nancially constrained rms.
[INSERT TABLE 7 HERE]
6 Valuation and Mergers
If high valuation signals better growth opportunity and not all rms are aected uniformly, high
valuation may also lead to higher intensity of asset reallocation through mergers and acquisition.
In this section, we investigates how valuation aects the rate of asset sales using both industry and
rm-level panels. For industry panel, we regress the rate of transaction in the next year on valuation
measures while controlling for other industry characteristics such as protability, asset turnover rate
and dummy for demand conditions (as dened above). Since mergers tend to cluster over time, we
also include a wave dummy which indicates years with abnormally high merger activity following
Maksimovic, Phillips and Yang (2010). All independent variables are lagged by one year and we
include industry xed eects in all specications:
% of Transactions
i;t+1
= c
i
+/ \ c|nctio:
i;t
+c A
it
14
Table 8 reports our ndings. Panel A shows that all three valuations (Tobins q, UV
RKRV
and
UV
PV
) predict high rate of transaction. When we include both Tobins q and UV measure in the
regression, the eect of q becomes smaller. In panel B, we split the total rate of transaction into
within and outside industry transactions based on whether the acquirer has operated in the same
industry before. On average, 60% of all transactions happen between rms in the same industry.
Interestingly, within and outside transactions are driven by dierent factors. Tobins q has a positive
relationship for within industry transactions, signicant at 1% level; but is insignicant in predicting
outside transactions. On the other hand, UV measures consistently predict outside acquisitions but
not within industry transactions. Firms are more likely to buy or sell assets within the industry
when Tobins q is high while industries with higher UVs are more likely to attract acquirers from
other industries.
[INSERT TABLE 8 HERE]
To better understand how merger decisions relate to industry and rm-specic valuation on both
sides of the trade, we analyze decisions to buy or sell assets on the rm level using the subsample
of public rms with the following specication:
1
j;i;t+1
= c
i
+,
t
+/ \ c|nctio:
i;t
+c

\ c|nctio:
j;i;t
\ c|nctio:
i;t

+c A
j;i;t
(8)
For purchase decisions, the dependent variable is an indicator variable which equals 1 if a rm
buys in the existing industry (Within Buy), 2 if it buys in a new industry(Outside Buy) and 0
otherwise. For sales decisions, the dependent variable equals 1 if a rm sells assets and 0 otherwise.
Table 9 Panel A presents our results on purchase decisions. Higher rm-specic valuation leads
to higher probability to purchase assets although the eect is stronger for within buy. On the
other hand, rms are more likely to buy assets in their existing industries if industry valuation
is high and they are more likely to buy assets in new industries when their existing industries
have lower valuation. In all specications, TFP has a positive coecient, suggesting that acquirers
have higher productivity. Although the signs are consistent using either UV
RKRV
or UV
PV
, the
statistical signicance is higher when UV
RKRV
is used as valuation measure. In Table 9 Panel B,
we present our ndings on decisions to sell assets. Sellers have lower rm-specic valuation and
lower productivity. In addition, rms are more likely to sell assets when they have high industry
valuation. Combining ndings from both panels, our result is consistent with the view that asset
sales serve as a channel to move resources from less to more productive rms within or across
15
industries. As such, it helps more productive rms to exit their own industry when opportunity is
not present and enter into industries when future is much brighter. Consistent with evidence from
our industry level analysis, industry valuation (both total and unexplained) is positively related to
the rate of transaction.
[INSERT TABLE 9 HERE]
Recent work, in particular by Shleifer and Vishny (2003) and Rhodes-Kropf, Robinson, and
Vishwanathan (2005) has argued that merger activity is to a large extent driven by misvaluation.
One implication of this work is that a signicant fraction of mergers might result in the misallocation
of assets to acquirers who may not be able to operate them eciently. If acquisition is driven by
misvaluation rather than eciency consideration, we would observe that target plants acquired by
overvalued buyers realize less or even negative change in productivity. To test this hypothesis,
we split the sample into three categories: no transaction, buyers with low-UV, and buyers with
high-UV, and compare changes in TFP in each group. We dene a buyer to have high-UV if its
unexplained valuation is above the median of all rms in our sample (based on RKRV). Table 10
Panel A presents our nding. The productivity of targets plants increases after the acquisition, and
the improvement is not smaller when acquirers have higher unexplained valuation. Similar results
are found when we use the level of UV - Panel B shows that the interaction between the indicator
variable for transaction (D_SALE) and UV is insignicant for all time windows.
[INSERT TABLE 10 HERE]
The problemwould be the most severe in diversifying mergers when rms in overvalued industries
buy assets in other industries to take advantage of the mispricing between industries, as suggested by
models of misvaluation-driven mergers. To examine how the dierence in industry valuation aects
merger outcomes, we construct a sample with only diversifying acquisitions in which acquirers did
not have presence in the industries they purchase assets from prior to the transaction. We further
divide the sample into two equally-sized groups based on the relative industry UV measures (based
on RKRV) between the buyer and seller. The low-RUV group includes transactions in which the
relative industry valuation between the buyer and seller is below the sample median and the high-
RUV group includes transaction in which the relative valuation is above the sample median. Table
11 Panel A compares change of TFP for transacted plants between low- and high-RUV groups one,
two and three years after the transaction. On average, transacted plants experience an increase
in productivity and the dierence is not signicantly dierent if the buyer comes from a relatively
16
highly valued industry than the seller. In other words, although higher unexplained valuation leads
to more acquisitions, it does not aect the post-merger productivity changes for transacted plants.
Table 11 Panel B show that among transacted plants in diversifying acquisitions, the improvement
of productivity is positively related to acquirers TFP in the home industry and the dierence in
Tobins q between the acquirer and the target rms.
[INSERT TABLE 11 HERE]
Our earlier analysis (in particular in Table 8 and 9) suggests that better rms use acquisitions to
enter new industries when their home industry have limited growth opportunity. Given that there is
about 40% of the cases in which buyers come from industries with higher relative valuation (mostly
in high-RUV group), a natural question to ask is that if valuation signals growth opportunity, why
would rms exit their home industry to enter a new industries with lower valuation? To answer
this question, for our sample of diversifying mergers, we track the change of valuation in acquirers
home industry after the acquisition and Table 11 Panel C reports our ndings. On average, after
the transaction, acquirers home industry experience drops in UV and the decrease is much bigger
in the high-RUV group in which acquirers are from relatively more valued industries. Although
preliminary, our nding points to a direction such that rms choose to exit from their existing
industries in expectation of lower future growth opportunities.
7 Conclusions
In this paper we investigate the relation between market (mis)valuation and the subsequent produc-
tivity of rms and industries. Using measures recently introduced by Pastor and Veronesi (2003)
and Rhodes-Kropf, Robinson and Vishwanathan (2005), we decompose rm valuation, measured by
Tobins q, into a portion that is predicted by observable characteristics and a portion, unexplained
valuation, that measures the deviation from the predicted level. In the literature, unexplained
valuation has been interpreted as "misvaluation," unrelated to the rms fundamental value.
We show that both Tobins q and the unexplained valuation predict future productivity similarly.
Firms with high valuation, are positively associated with higher changes in productivity in the
future. We also investigate how valuation, both Tobins q and the unexplained portion, predict
investment activities such as capital expenditure and acquisition decisions. Both Tobins q and
unexplained valuation predict increased capital expenditures. Firms invest more both when they
17
have higher valuations and when their industry has a higher valuation. Financially constrained
rms show a stronger sensitivity of capital expenditures to valuation.
High valuations, both Tobins q and unexplained, also predict acquisitions and sales. Examining
both within and across industry acquisitions, we nd that rms with high rm-specic valuation are
more likely to buy assets in their existing industries when industry valuation is high, and are more
likely to acquire assets to enter other industries when their existing industry has a low valuation.
Sales of assets are more likely when a rm has low rm-specic valuation, but industry valuation
is high. Our ndings suggest that asset sales serve as a channel to move resources from less to
more productive rms within or across industries. It helps more productive rms to exit their own
industry when opportunity is not present and enter into industries when future is much brighter.
Examining acquisitions across industries, we nd that the productivity of targets plants in-
creases after the acquisition. The increase is not smaller when the acquirer has higher unexplained
valuation or is from a relatively more overvalued industry. Thus, while industry (mis)valuation
predicts acquisitions, there is no evidence that high industry valuation leads to inecient diversi-
cation or a misallocation of investment. We interpret the positive association between unexplained
valuation and Total Factor Productivity documented in our paper (even controlling for Tobins q)
as an indication that unexplained valuation might be proxying for a relaxation of either nancing or
informational constraints facing rms, rather than being a measures of misvaluation and reecting
changes in investor sentiment unmoored from rm and industry fundamentals.
18
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20
Figure 1: TFP and Valuation
This figure shows the time series plot of TFP, Tobin's Q and misvaluation measures calculated based on
RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi (2003).
0
0.05
0.1
0.15
0.2
0.25
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1
9
7
6
1
9
7
7
1
9
7
8
1
9
7
9
1
9
8
0
1
9
8
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9
8
2
1
9
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3
1
9
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4
1
9
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5
1
9
8
6
1
9
8
7
1
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8
1
9
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1
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4
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2
0
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0
2
0
0
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2
0
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2
0
0
3
T
F
P
TFP and Tobin's Q
Tobin's q TFP
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
Misvaluation Measures
MISV_RKRV MISV_PV
Panel A
(1) (2) (3) (4) (5)
Tobin's Q 0.014 *** 0.007 0.010 **
(0.004) (0.005) (0.005)
UV_RKRV 0.012 *** 0.009 **
(0.003) (0.004)
UV_PV 0.016 *** 0.013 ***
(0.004) (0.004)
Lagged TFP 0.888 *** 0.897 *** 0.897 *** 0.894 *** 0.893 ***
(0.011) (0.011) (0.011) (0.011) (0.011)
Constant -0.001 0.014 *** 0.015 *** 0.006 0.005
(0.004) (0.002) (0.002) (0.005) (0.005)
R-Square 0.8051 0.8082 0.8113 0.8087 0.8121
N 2764 2627 2456 2627 2456
Panel B
(1) (2) (3) (4) (5)
Tobin's Q 0.020 *** 0.005 0.013 **
(0.006) (0.006) (0.005)
UV_RKRV 0.018 *** 0.016 ***
(0.005) (0.006)
UV_PV 0.025 *** 0.020 ***
(0.005) (0.005)
Lagged TFP 0.782 *** 0.782 *** 0.805 *** 0.781 *** 0.801 ***
(0.064) (0.069) (0.068) (0.069) (0.067)
Constant 0.004 0.026 *** 0.025 *** 0.02 ** 0.012
(0.010) (0.006) (0.006) (0.009) (0.008)
Chi Sq. 154 131 154 132 170
N 2612 2473 2320 2473 2320
This table reports regression results from industry level regressions. Panel A reports the estimated
coefficient using industry fixed effect models and panel B reports estimated coefficients using
dynamic panel models based on GMM estimator derived in Arellano and Bond (1991). In both
panels, the dependent variables are TFP in the next period and independent variables include Tobin's
Q, MISV based on RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi
(2003) respectively and current period TFP. We include industry and year fixed effects in all
specifications. The Robust standard errors allow clustering at the industry level and are reported in
parentheses. *, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
Table 1: TFP and Valuation (Industry Level)
Panel A:
(1) (2) (3) (4) (5) (6)
Tobin's Q -0.004 0.023 ***
(0.010) (0.006)
UV_RKRV -0.002 0.020 ***
(0.008) (0.005)
UV_PV 0.012 0.022 ***
(0.007) (0.005)
TFP 0.658 *** 0.593 *** 0.626 *** 0.862 *** 0.865 *** 0.881 ***
(0.033) (0.035) (0.035) (0.016) (0.016) (0.016)
Constant 0.040 *** 0.043 *** 0.039 *** -0.008 0.018 *** 0.018 ***
(0.010) (0.004) (0.004) (0.006) (0.002) (0.002)
Chi Sq 401 306 319 2977 3004 3127
N 812 732 633 1800 1741 1687
Table 2: TFP and Valuation (Industry Level) - Robustness Checks
This table reports regression results from industry level regressions based on different sample splits. Panel A splits the
sample based on percentage of the public firms, Panel B splits the sample based on concentration ratio using
Herfindahl Index (of sales); Panel C splits the sample using the percentage of small firms (<50 employees) within the
industry. Panel D splits the sample based on the ratio of capital expenditure over lagged assets. For each panel, the
dependent variable is the TFP in the next year and the independent variables include Tobin's Q, MISV based on
RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi (2003), respectively, and current TFP.
The coefficients are estimated using GMM estimator derived in Arellano and Bond (1991). We include industry and
year fixed effects in all specifications. The Robust standard errors allow clustering at the industry level and are
reported in parentheses. *, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
Low Public Industries High Public Industries
Panel B
(1) (2) (3) (4) (5) (6)
Tobin's Q 0.025 *** 0.009
(0.005) (0.010)
UV_RKRV 0.014 *** 0.016 *
(0.004) (0.008)
UV_PV 0.012 *** 0.030 ***
(0.004) (0.009)
TFP 0.625 *** 0.588 *** 0.611 *** 0.858 *** 0.876 *** 0.900 ***
(0.024) (0.024) (0.025) (0.021) (0.020) (0.019)
Constant 0.013 ** 0.044 *** 0.043 *** 0.011 0.019 *** 0.019 ***
(0.006) (0.003) (0.003) (0.011) (0.003) (0.003)
Chi Sq 704 578 589 1754 1939 2317
N 1608 1550 1501 1004 923 819
Panel C
(1) (2) (3) (4) (5) (6)
Tobin's Q 0.005 0.030 ***
(0.006) (0.008)
UV_RKRV 0.009 0.021 ***
(0.005) (0.005)
UV_PV 0.009 * 0.031 ***
(0.005) (0.006)
TFP 0.571 *** 0.540 *** 0.574 *** 0.889 *** 0.891 *** 0.904 ***
(0.029) (0.029) (0.028) (0.017) (0.016) (0.016)
Constant 0.047 *** 0.057 *** 0.052 *** -0.017 ** 0.014 *** 0.016 ***
(0.008) (0.004) (0.004) (0.008) (0.002) (0.002)
Chi Sq 392 359 424 3060 2938 3053
N 1201 1136 1060 1411 1337 1260
Panel D
(1) (2) (3) (4) (5) (6)
Tobin's Q 0.032 *** 0.005
(0.007) (0.007)
UV_RKRV 0.022 *** 0.012 *
(0.005) (0.007)
UV_PV 0.025 *** 0.017 **
(0.005) (0.007)
TFP 0.688 *** 0.640 *** 0.673 *** 0.873 *** 0.875 *** 0.882 ***
(0.025) (0.025) (0.026) (0.018) (0.018) (0.018)
Constant -0.001 0.034 *** 0.033 *** 0.013 0.019 *** 0.019 ***
(0.007) (0.003) (0.003) (0.009) (0.003) (0.003)
Chi Sq 766 656 714 2234 2268 2520
N 1290 1207 1123 1322 1266 1197
Low Capex Industries High Capex Industries
Competitive Industries Concentrated Industries
Small Firm Industries Large Firm Industries
(1) (2) (3)
ITobin'Q 0.0237 ***
(0.001)
Large * ITobin's Q 0.0148 ***
(0.001)
HighTFP * ITobin's Q 0.0375 ***
(0.001)
IUV_RKRV 0.0191 ***
(0.002)
Large * IUV_RKRV 0.0202 ***
(0.002)
HighTFP * IUV_RKRV 0.0162 ***
(0.002)
IUV_PV -0.0007
(0.002)
Large * IUV_PV 0.0001
(0.002)
HighTFP * IUV_PV -0.0056 **
(0.002)
TFP 0.5453 *** 0.6086 *** 0.6093 ***
(0.002) (0.001) (0.001)
Constant 0.0009 -0.0012 *** -0.001 ***
(0.001) (0.000) (0.000)
R-Square 0.37 0.36 0.36
N 463944 454937 442847
Table 3 TFP, Misvaluation and Firm Characteristics
This table reports firm level regression results. The dependent variable is firm-level TFP
(demeaned from industry average) in the next period. ITobin's Q is the industry average
Tobin's q, IUV_RKRV and IUV_PV are industry average misvaluation measures based on
RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi (2003),
respectively. Large is a dummy variable that equals to 1 if firm size is greater than the
industry median, and HighTFP is a dummy variable that equals to 1 if firm TFP is greater
than the industry median. All independent variables are lagged. We include industry and year
fixed effects in all specifications. The Robust standard errors allow clustering at the industry
level and are reported in parentheses. *, ** and *** represent significance at 10%, 5%, and
1% level, respectively.
(1) (2) (3) (4) (5)
Tobin's Q 0.0101 *** 0.0095 ** 0.0124 ***
(0.003) (0.004) (0.004)
UV_RKRV 0.0078 ** 0.0046
(0.003) (0.003)
UV_PV -0.0036 -0.0051 *
(0.003) (0.003)
Lagged TFP 0.3901 *** 0.3857 *** 0.3783 *** 0.3854 *** 0.3780 ***
(0.008) (0.008) (0.008) (0.008) (0.008)
Constant 0.0291 *** 0.0294 *** 0.0318 *** 0.0293 *** 0.0315 ***
(0.001) (0.001) (0.001) (0.001) (0.001)
Chi Sq. 2657 2491 2186 2500 2199
N 45155 43151 39784 43151 39784
Table 4: TFP and Valuation (Firm Level)
This table reports results from firm level regressions. It reports estimated coefficients using dynamic
panel models based on GMM estimator derived in Arellano and Bond (1991). In both panels, the
dependent variables are TFP in the next period, and independent variables include Tobin's Q, MISV
based on RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi (2003)
respectively and TFP in the current period. For Panel B, we exclude firms with less than 10 years of
data. The Robust standard errors allow clustering at the industry level and are reported in
parentheses. *, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
(1) (2) (3)
Tobin's Q 1.050 *** 0.684 ** 1.542 ***
(0.294) (0.312) (0.302)
UV_RKRV 1.344 ***
(0.300)
UV_PV 1.098 ***
(0.264)
OPMARG 0.103 -0.527 -0.781
(1.107) (1.033) (1.091)
ATTURN 0.153 *** 0.185 *** 0.203 ***
(0.038) (0.036) (0.036)
D_ECON=2 0.244 0.25 0.215
(0.181) (0.169) (0.171)
D_ECON=3 0.751 *** 0.683 *** 0.66 ***
(0.207) (0.193) (0.196)
CONSTANT 11.952 *** 12.84 *** 11.853 ***
(0.514) (0.547) (0.519)
R-Square 0.4289 0.4853 0.5037
N 2494 2368 2209
Table 5 Valuation and Capital Expenditure (Industry Level)
This table reports industry level regression results. The dependent variable is the
average capital expenditure ratio (over lagged assets) in the industry (in percentage).
Tobin's Q is the average Tobin's Q in the industry. MISV_RKRV and MISV_PV are
industry misvaluation measures based on RhodesKropf, Robinson and Vishwanathan
(2005) and Pastor and Veronesi (2003), respectively. OPMARG is the industry average
operating margin (computed as the ratio of operating income over sales), ATTURN is
the rate of asset turnover (computed as the sales over total assets). D_Econ is a dummy
variable which equals 1 if changes in industry shipments are negative in the past two
consecutive years, 3 if industry shipments are positive in the past two consecutive years
and 2 otherwise. All independent variables are lagged. We include industry fixed effects
and year fixed effects in all specifications. The Robust standard errors allow clustering
at the industry level and are reported in parentheses. *, ** and *** represent
significance at 10%, 5%, and 1% level, respectively.
(1) (2) (3) (4) (5)
ITobin's Q 0.0444 *** 0.0273 *** 0.0388 ***
(0.005) (0.006) (0.006)
Firm Tobin's Q 0.0248 *** 0.0217 *** 0.0220 ***
(0.001) (0.002) (0.002)
IUV_RKRV 0.0528 *** 0.0372 ***
(0.005) (0.006)
Firm UV_RKRV 0.0260 *** 0.0108 ***
(0.002) (0.002)
IUV_PV 0.0338 *** 0.0239 ***
(0.005) (0.006)
Firm UV_PV 0.0103 *** 0.0038 *
(0.002) (0.002)
Ind_TFP 0.0406 *** 0.0295 ** 0.0097 0.0369 *** 0.0243 *
(0.014) (0.014) (0.015) (0.014) (0.015)
Firm TFP 0.0302 *** 0.0266 *** 0.027 *** 0.0259 *** 0.0257 ***
(0.004) (0.004) (0.004) (0.004) (0.004)
Size -0.0203 *** -0.0208 *** -0.0182 *** -0.0206 *** -0.0186 ***
(0.001) (0.001) (0.001) (0.001) (0.001)
OPMARG 0.0151 *** 0.0225 *** 0.0242 *** 0.0183 *** 0.0187 ***
(0.005) (0.005) (0.006) (0.005) (0.006)
D_Main 0.0165 *** 0.0173 *** 0.0083 *** 0.0165 *** 0.0093 ***
(0.002) (0.002) (0.002) (0.002) (0.002)
Change in Shipments 0.013 ** 0.0114 * 0.0172 *** 0.0098 0.0138 **
(0.006) (0.006) (0.007) (0.006) (0.007)
Constant 0.3314 *** 0.3837 *** 0.3525 *** 0.356 *** 0.3221 ***
(0.010) (0.009) (0.009) (0.011) (0.010)
R-Square 0.031 0.029 0.026 0.032 0.030
N 62922 59104 52375 59104 52375
Table 6: Valuation and Capital Expenditure (Firm Level)
This table reports firm level regression results. The dependent variable is the rate of capital expenditure
(over lagged assets). ITobin's Q is the industry Tobin's Q. IUV_RKRV and IUV_PV are industry
misvaluation measure based on RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and
Veronesi (2003), respectively. Tobin's Q, UV_RKRV and UV_PV are firm-level demeaned Tobin's Q
and misvaluation measures. Firm TFP and Ind_TFP measure the demeaned firm level TFP and the
industry average TFP. Size is the log of firm output. OPMARG is the operating margin computed as the
operating income over total sales. D_main is a dummy variable which equals to 1 if it is firm's main
segment. Change in Shipments is the percentage change of shipments from the last to the current year.
All independent variables are lagged. We include industry fixed effects and year fixed effects in all
specifications. The Robust standard errors allow clustering at the industry level and are reported in
parentheses. *, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
(1) (2) (3)
ITobin's Q 0.0448 ***
(0.005)
Firm Tobin's Q 0.0358 ***
(0.002)
Rated * Tobin's Q -0.0166 ***
(0.002)
IUV_RKRV 0.0525 ***
(0.005)
Firm UV_RKRV 0.0327 ***
(0.002)
Rated * Firm UV_RKRV -0.0128 ***
(0.002)
IUV_PV 0.0337 ***
(0.005)
Firm UV_PV 0.0136 ***
(0.002)
Rated * Firm UV_PV -0.0059 **
(0.002)
Rated 0.0025 ** 0.003 ** 0.0036 ***
(0.001) (0.001) (0.001)
Ind_TFP 0.0415 *** 0.0303 ** 0.01
(0.014) (0.014) (0.015)
Firm TFP 0.0305 *** 0.0264 *** 0.0269 ***
(0.004) (0.004) (0.004)
Size -0.0206 *** -0.021 *** -0.0188 ***
(0.001) (0.001) (0.001)
OPMARG 0.0151 *** 0.0226 *** 0.0238 ***
(0.005) (0.005) (0.006)
D_Main 0.0171 *** 0.0182 *** 0.0105 ***
(0.002) (0.002) (0.002)
Change in Shipments 0.0125 ** 0.0111 * 0.0172 ***
(0.006) (0.006) (0.007)
Constant 0.3338 *** 0.3848 *** 0.3554 ***
(0.010) (0.009) (0.009)
R-Square 0.0323 0.0299 0.0257
N 62922 59104 52375
Table 7: Valuation, Rating and Capital Expenditure (Firm Level)
This table reports firm level regression results. The dependent variable is the capital expenditure
ratio (over lagged assets). ITobin's Q is the industry Tobin's Q. IUV_RKRV and IUV_PV are
industry misvaluation measure based on RhodesKropf, Robinson and Vishwanathan (2005) and
Pastor and Veronesi (2003), respectively. Tobin's Q, UV_RKRV and UV_PV are firm-level
demeaned Tobin's Q and misvaluation measures. Rated is a dummy variable which equals to 1 if a
firm has a debt rating and 0 otherwise. Firm TFP and Ind_TFP measures the demeaned firm level
TFP and the industry average TFP. Size is the log of firm total output. OPMARG is the operating
margin computed as the operating income over total sales. D_main is a dummy variable which
equals to 1 if it is firm's main segment. Change in Shipments is the percentage change of
shipments from the last to the current year. All independent variables are lagged. We include
industry fixed effects and year fixed effects in all specifications. The Robust standard errors allow
clustering at the industry level and are reported in parentheses. *, ** and *** represent
significance at 10%, 5%, and 1% level, respectively.
Panel A (1) (2) (3)
Tobin's Q 0.888 *** 0.287 0.537 **
(0.198) (0.232) (0.214)
UV_RKRV 0.877 ***
(0.209)
UV_PV 0.462 **
(0.204)
OPMARG -0.546 -1.257 -1.006
(0.972) (0.971) (0.980)
ATTURN -0.062 ** -0.074 ** -0.079 **
(0.031) (0.030) (0.031)
D_ECON=2 0.005 0.042 0.037
(0.152) (0.153) (0.153)
D_ECON=3 -0.195 -0.168 -0.182
(0.159) (0.160) (0.160)
GW_N 1.919 *** 2.023 *** 2.027 ***
(0.379) (0.403) (0.398)
CONSTANT 3.314 *** 4.092 *** 3.832 ***
(0.379) (0.403) (0.398)
R-Square 0.1381 0.1457 0.15
N 2070 1996 1907
Table 8: Valuation and Asset Sales (Industry Level)
This table reports industry level regression results. In Panel A, the dependent variable is the rate of
transaction in the industry (in percentage). In Panel B, we separate transactions in which acquirer firm is
from the same industry (within industry transaction) from transactions in which acquirer firm is from a
different industry (outside industry transactions) and the dependent variable is the percentage of
transaction in the corresponding category. Tobin's Q is the industry Tobin's Q. UV_RKRV and UV_PV are
industry misvaluation measures based on RKRV(2005) and PV(2003), respectively. OPMARG is the
industry average operating margin (computed as the ratio of operating income over sales), ATTURN is the
rate of asset turnover (computed as the sales over total assets). D_Econ is a dummy variable which equals
1(3) if changes in industry shipments are negative(positive) in the past two consecutive years and 2
otherwise. GW_N is a dummy variable that indicates high transaction volume years (based on
Maksimovic, Phillips and Yang (2010). All independent variables are lagged. We include industry fixed
effects and year fixed effects in all specifications. The Robust standard errors allow clustering at the
industry level and are reported in parentheses. *, ** and *** represent significance at 10%, 5%, and 1%
level, respectively.
Panel B
(1) (2) (3) (4)
Tobin's Q 0.534 *** 0.466 *** -0.247 0.071
(0.166) (0.151) (0.167) (0.157)
UV_RKRV -0.104 0.981 ***
(0.149) (0.150)
UV_PV -0.135 0.597 ***
(0.143) (0.149)
OPMARG -1.311 * -1.266 * 0.054 0.260
(0.694) (0.689) (0.699) (0.716)
ATTURN -0.039 * -0.043 * -0.034 -0.036
(0.022) (0.022) (0.022) (0.023)
D_ECON=2 0.128 0.061 -0.086 -0.024
(0.109) (0.107) (0.110) (0.112)
D_ECON=3 0.018 -0.021 -0.186 -0.161
(0.114) (0.113) (0.115) (0.117)
GW_N 1.175 *** 1.194 *** 0.849 *** 0.833 ***
(0.090) (0.089) (0.091) (0.092)
CONSTANT 1.451 *** 1.553 *** 2.641 *** 2.279 ***
(0.288) (0.280) (0.290) (0.291)
R-Square 0.110 0.119 0.064 0.054
N 1996 1996 1907 1907
Within Industry Transactions Outside Industry Transactions
Panel A
Firm Tobin's Q 0.88 *** 0.12
(0.10) (0.10)
ITobin's Q 0.01 -1.18 ***
(0.20) (0.20)
Firm UV_RKRV 1.48 *** 0.23 *
(0.20) (0.10)
IUV_RKRV 0.71 ** -0.60 **
(0.40) (0.30)
Firm UV_PV 0.27 0.03
(0.20) (0.10)
IUV_PV 0.42 -0.34
(0.40) (0.30)
SIZE 1.48 *** -0.60 *** 1.43 *** -0.59 *** 1.44 *** -0.49 ***
(0.10) (0.00) (0.10) (0.00) (0.10) (0.00)
TFP -0.15 0.27 *** -0.15 0.25 *** -0.08 0.26 ***
(0.10) (0.10) (0.10) (0.10) (0.10) (0.10)
D_Main 5.51 *** -4.18 *** 5.49 *** -4.35 *** 5.45 *** -4.11 ***
(0.20) (0.10) (0.20) (0.10) (0.20) (0.10)
Change in Shipments -1.53 *** 1.49 *** -1.67 *** 1.40 *** -1.55 *** 1.26 ***
(0.50) (0.30) (0.50) (0.30) (0.50) (0.30)
HERF -13.68 *** 8.03 *** -13.38 *** 8.38 *** -13.48 *** 7.96 ***
(2.10) (1.20) (2.10) (1.20) (2.20) (1.20)
CI_Spread -1.53 *** -1.11 *** -1.43 *** -0.81 *** -1.52 *** -0.78 ***
(0.30) (0.20) (0.30) (0.20) (0.30) (0.20)
SP Ret 1.78 *** 0.18 1.40 ** 0.38 1.35 * 0.19
(0.60) (0.40) (0.70) (0.50) (0.70) (0.50)
Chi Square 1900 1800 1600
N 61705 58657 52614
Diver. Buy
(1) (2) (3)
Within Buy Diver. Buy Within Buy Diver. Buy Within Buy
Table 9: Valuation and Decision to Buy Assets (Firm Level)
This table reports the marginal effect(multiplied by 100) of probit models. In Panel A, the dependent variable
equals to 1 if a firm buys assets in existing industries, 2 if a firms buys assets in new industries, and 0 otherwise.
In Panel B, the dependent variable is a binary variable that equals to 1 if a firm sells assets in the next period.
ITobin's Q is the industry Tobin's Q. IUV_RKRV and IUV_PV are industry misvaluation measure based on
RhodesKropf, Robinson and Vishwanathan (2005) and Pastor and Veronesi (2003), respectively. Tobin's Q,
UV_RKRV and UV_PV are firm-level demeaned Tobin's Q and misvaluation measures. Firm TFP measures the
demeaned firm level TFP . Size is the log of firm total output. D_main is a dummy variable which equals to 1 if
it is firm's main segment. Change in Shipments is the percentage change of shipments from the last to the current
year. HERF is the Herfindahl index based on sales. CI_Spread is the credit spread and SP Ret is the return of
S&P 500. All independent variables are lagged. The Robust standard errors allow clustering at the industry level
and are reported in parentheses. *, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
Panel B: Decision to Sell Assets
(1) (2) (3) (4) (5)
Firm Tobin's Q -1.49 *** -1.93 *** -1.56 ***
(0.20) (0.20) (0.20)
ITobin's Q 0.15 -0.28 -0.07
(0.30) (0.30) (0.30)
Firm UV_RKRV -0.22 1.05 ***
(0.20) (0.20)
IUV_RKRV 2.48 *** 2.47 ***
(0.40) (0.40)
Firm UV_PV -0.16 1.78 ***
(0.20) (0.50)
IUV_PV 1.95 *** 0.28
(0.50) (0.20)
SIZE 1.38 *** 1.39 *** 1.40 *** 1.39 *** 1.43 ***
(0.10) (0.10) (0.10) (0.10) (0.10)
TFP -2.09 *** -2.40 *** -2.63 *** -2.19 *** -2.40 ***
(0.40) (0.40) (0.40) (0.40) (0.40)
D_Main -5.34 *** -5.17 *** -5.16 *** -5.08 *** -5.21 ***
(0.20) (0.20) (0.20) (0.20) (0.20)
Change in Shipments -0.93 -1.11 * -0.85 -1.06 * -0.87
(0.60) (0.60) (0.60) (0.60) (0.60)
HERF -7.12 *** -7.48 *** -6.52 *** -8.00 *** -7.18 ***
(2.30) (2.40) (2.50) (2.40) (2.50)
CI_Spread -3.39 *** -3.39 *** -3.23 *** -3.44 *** -3.35 ***
(0.30) (0.30) (0.30) (0.30) (0.30)
SP Ret 1.19 -0.07 0.28 -0.08 0.23
(0.70) (0.80) (0.90) (0.80) (0.80)
R-Square 0.032 0.031 0.031 0.034 0.033
N 64925 61520 54906 61520 54906
Panel A
Dependent Variable
Variable Name (1) (2) (3) (4) (5) (6)
D_Sale = 1 & D_UV=0 0.026 *** 0.023 *** 0.039 *** 0.037 *** 0.026 *** 0.027 ***
(0.00) (0.00) (0.01) (0.01) (0.01) (0.01)
D_Sale = 1 & D_UV=1 0.050 *** 0.033 *** 0.060 *** 0.044 *** 0.065 *** 0.054 ***
(0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
TFP -0.021 *** -0.034 *** -0.038 ***
(0.00) (0.00) (0.00)
Ln(Output) 0.057 *** 0.067 *** 0.068 ***
(0.00) (0.00) (0.00)
Constant -0.012 ** -0.621 *** -0.020 *** -0.748 *** -0.028 *** -0.774 ***
(0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
Number of Obs 769,431 769,431 643,675 643,675 529,646 529,646
R-Square 0.1% 1.1% 0.1% 1.3% 0.2% 1.2%
Panel B
Dependent Variable
Variable Name (1) (2) (3) (4) (5) (6)
D_Sale 0.029 *** 0.025 *** 0.042 *** 0.038 *** 0.032 *** 0.031 ***
(0.00) (0.00) (0.00) (0.00) (0.01) (0.01)
D_Sale * UV 0.012 0.002 0.019 0.009 0.008 -0.001
(0.01) (0.01) (0.02) (0.02) (0.02) (0.02)
TFP -0.021 *** -0.034 *** -0.038 ***
(0.00) (0.00) (0.00)
Ln(Output) 0.057 *** 0.067 *** 0.068 ***
(0.00) (0.00) (0.00)
Constant -0.012 ** -0.621 *** -0.020 *** -0.748 *** -0.028 *** -0.774 ***
(0.01) (0.01) (0.01) (0.01) (0.01) (0.01)
Number of Obs 769,431 769,431 643,675 643,675 529,646 529,646
R-Square 0.1% 1.1% 0.1% 1.3% 0.2% 1.2%
TFP (-1,1) TFP(-1,2) TFP(-1,3)
Table 10: Robustness Checks: Change of TFP and Valuation
This table reports regression estimates on changes of TFP on the establishment level controlling for buyer's valuation.
D_Sale is an indicator variable that equals to 1 if the establishment is sold and 0 otherwise. D_UV is an indicator variable
that equals to 1 if buyer's UV is above the sample median and 0 otherwise. We calculate UV using the procedure of
Rhodes-Kropft, Robinson and Viswanathan (2005) as updated by Hoberg and Phillips (2009). TFP(-1, 1) is the change of
TFP from t-1 to t+1 with t being the current year. Similarly, TFP(-1,2) and TFP(-1,3) measure change of TFP from t-1 to
t+2 and t+3, respectively. We control for industry fixed effects and robust standard errors are reported in the parentheses.
*, ** and *** represent significance at 10%, 5%, and 1% level, respectively.
TFP (-1,1) TFP(-1,2) TFP(-1,3)
Panel A: Change of TFP
Chgtfp (-1, 1) ChgTFP(-1, 2) ChgTFP(-1, 3)
Low RUV Group 3.67% 3.67% 5.50%
High RUV Group 4.42% 3.14% 4.81%
Difference -0.74% 0.53% 0.68%
T-Stat -0.342 0.292 0.262
Pvalue 0.732 0.826 0.794
Panel B: Change of TFP (Regressions)
Chgtfp (-1, 1) ChgTFP(-1, 2) ChgTFP(-1, 3)
Acquirer TFP 0.202 *** 0.292 *** 0.181 **
-0.067 -0.077 -0.085
B_IUV - S_IUV -0.007 -0.093 -0.043
-0.059 -0.065 -0.073
B_ITobinQ - S_ITobinQ 0.06 0.124 ** 0.131 **
-0.046 -0.052 -0.059
Constant 0.032 *** 0.023 * 0.047 ***
-0.011 -0.013 -0.014
R-Square 0.002 0.004 0.002
N 5652 4867 4220
Panel C: Changes of Valuation in the Home Industries
Chg_MISV(-1, 1) Chg_Q(-1, 1)
Low RUV Group 2.34% 2.89%
High RUV Group -5.09% 1.07%
Difference 0.074 0.018
T-Stat 11.84 3.6159
Pvalue <0.0001 0.0003
Table 11: Diversifying Acqusitions
This table presents summary statistics and regression estimates for diversifying acquisitions. Panel A compares
changes of TFP one, two and three years after the transaction between Low and High RUV transaction groups.
Panel B presents the estimated coefficients in regressions when we have changes of TFP as dependent variable.
The independent variables include Acquirer's TFP in the home industry (before transaction), difference in
industry UV between acquirer and target, and difference in industry Q between acquirer and target. For
acquirers that operate in more than one industries before the acquisition, we use the weighted average industry
Q and UV based on sales.Panel C compares changes of misvaluation measure (UV) and Tobin's Q in acquirer's
home industry one year after the transactions in Low and High RMISV transaction groups. The Robust standard
errors allow clustering at the industry level and are reported in parentheses. *, ** and *** represent significance
at 10%, 5%, and 1% level, respectively.