Negative-Book-Value Firms and Their Valuation

ABSTRACT

We document a phenomenon that, along with the increasing trend of negative earnings, the frequency and the magnitude of negative book value of equity have also grown substantially over time. Although negative-book-value firms are commonly perceived as financially distressed, we find that the majority of these firms survive for a long time, and that many continue to report negative book value for several years. Over the most recent decade of our 30-year test period, 1976–2005, we find that based on per-dollar of assets, the market, on average, prices negative-book-value firms higher than positive-book-value firms. In addition, we discover that the correlation between market value and book value for negative-book-value firms is negative. Searching for explanations of these phenomena, we examine R&D expenditures of negative-book-value firms. Our results indicate that R&D, especially R&D accumulated over time, not only contributes to the increasing trend of negative-book-value incidences, but also plays an important role in the market's valuation of firms that concurrently report negative earnings and negative book value.

Keywords:  book value of equity, negative book value, valuation, losses, R&D, accounting conservatism

Ching-Lih Jan is a Professor at California State University, East Bay, and Jane A. Ou is an Associate Professor at Santa Clara University.

Source : Ching-Lih Jan and Jane A. Ou (2012) Negative-Book-Value Firms and Their Valuation. Accounting Horizons: March 2012, Vol. 26, No. 1, pp. 91-110.