R2: Does it Matter for Firm Valuation?

Abstract

A considerable amount of research has been devoted to why R2 differs across firms or markets, but little attention has been paid to the consequences of this difference. We fill this gap by investigating how differing R2 affects investors’ assessment of firm value. Using a sample of 90,111 firm-year observations from 1970 to 2004, we find that higher R2 leads to higher firm valuation and that, on average, high-R2 firms experience significant underperformance in the long run. These results suggest that high-R2 firms tend to be overpriced.