Going Negative: What to Do with Negative Book Equity Stocks

Abstract

1. Stephen J Brown 1. is David S. Loeb professor of finance at the Stern School of Business, New York University, in New York, NY. (sbrown{at}stern.nyu.edu) 2. Paul Lajbcygier 1. is an associate professor at Monash University, Faculty of Business and Economics, in Clayton, VIC, Australia. (paul.lajbcygier{at}buseco.monash.edu.au) 3. Bob Li 1. is a doctoral candidate at Monash University in Clayton, VIC, Australia. (bob.li{at}buseco.monash.edu.au) <!-- --> 1. To order reprints of this article, please contact Dewey Palmieri at dpalmieri@iijournals.com or 212-224-3675 . A firm’s book equity is a measure of the value held by a firm’s ordinary shareholders. Increasingly, it is being reported as a negative number. Because a firm’s limited liability structure means that shareholders cannot have negative value, negative book equity has no obvious interpretation. Consequently, both practitioners and academics typically omit such stocks in their analysis. While these stocks are small in number, they are disproportionately represented in extreme growth–value sectors and, therefore, can have an impact on applications where value is defined in terms of book equity. The authors propose a new approach that classifies negative book equity stocks across the growth–value spectrum by considering how close their returns correspond to those of stocks that fit more obviously into these classifications. They find that this new value factor, which includes negative book equity stock, is economically and statistically different from the old value factor that excludes such stocks. Although they illustrate how this approach can be used to classify negative book equity stock, the approach is quite general and may be used whenever particular accounting data are unavailable or otherwise suspect. TOPICS: [Equity portfolio management][1], [exchanges/markets/clearinghouses][2], [in markets][3] [1]: https://www.pm-research.com/topic/equity-portfolio-management [2]: https://www.pm-research.com/topic/exchangesmarketsclearinghouses [3]: https://www.pm-research.com/topic/markets