Abstract
Only those high B/M firms that have decreased in size earn the value premium. These firms follow conservative investment policies, while those high B/M firms that do not earn the value premium generate low cash flows. This difference explains why HML is redundant in some asset pricing models include profitability and investment factors, but not others. Profitability and investment factors subsume HML's ability to predict economic growth, implying that expected growth is high when profitable firms that invest conservatively earn high returns. Our result on the relation between the value premium and changes in firm size provides a testable restriction for theories of value: if a value premium within the model remains when controlling for changes in firm size, such a model is inconsistent with the data.
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