The Cost of Innovation and Decreasing Book Equity of U.S. Firms
Abstract
This study documents that book equity of U.S. firms has decreased dramatically over time and such decrease is systematic across various industries and firm size. Our analysis shows that intangible capital investment explains a significant portion of the decrease in book equity even after controlling for concurrent effect of leverage and profitability on book equity, and the effect of intangible capital investment on book equity increased in recent years. Further analysis shows that intangible capital contributes to decrease in book equity mostly through the channel of changing firm characteristics rather than changing sensitivity over time. Our findings suggest that investors must incorporate the effect of intangible capital investment into their valuation analysis, as indexes or investment strategies relying on indicators constructed by book equity may be biased and misleading.
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