Book to Market Ratio:
researches have been taking place on this topic before and explain the
relation. According to Fama and French (1992) firms whose book to market ratio
is higher also have higher expected stock return while Kothari and Shanken
(1997) make the study on Dow Jones Industrial Index (DJIA) by using the
Bayesian model over the period of 1926 to 1991 and suggests that sometimes B/M
ratio have negative impact on stock return, however, on the latter half of
their selected sample this finding does not apply.
Many researchers suggest different reasons for
high return with high B/M ratio companies, according to Fama and French (1993,
1996), those high returns are actually the compensation of systematic risk,
while Lakonishok, Shleifer, and Vishny (1994) explain the reason for higher
return is basically due to those investors who wrongly deduce the results by
studying previous earnings and growth, they assume that those firms which were
doing well in past would further continue in the same manner and those who
didn’t do well in past also don’t show any good progress in the future.
(2002) suggests three factor model in which he explains that B/M ratio, firm
size along with E/P ratio are the ultimate factors for the compensation of risk
for the selected sample of Hong Kong stock market.
Shleifer, and Vishny (1994) explains that those firms which have higher book to
market ratio, earning to price ratio and cash flow to price ratio performs far
better than those firms which have lower of those above ratios.
Firm size is also one
of the factors which has impact on the stock return, Gabriel and Allan (2000)
suggests a negative relation between firm size and expected return and the
reason they explain for the higher return is liquidity risk, small firms face
liquidity issue in the time of distress so to compensate the investors of small
firms, pay higher returns.
Benz (1981) found in
his study that returns of small firms are actually more risk adjusted than of
large firms. Barry and Brown (1984) explain that availability of information
can be another aspect of higher returns on small firm’s stock and for this
argument they give the explanation that as the information related to small
firms are less likely available so they would be considered as more riskier
stock so in order to compensate the risk small companies need to pay more
returns to their investors.
Chui and Wei (1998)
also studied the relationship between stock return and beta (which is actually
a measure of systematic risk), book to market ratio and size of the firm. Their
selected sample was Pacific-Basin and they concluded that firm size has a very
powerful effect on stock return excluding the stock of Taiwan market. Chan et
al., (1991) selected the Tokyo Stock exchange as their sample including both
manufacturing and non-manufacturing firms and also listed and delisted firms
and found out that small size firms outperform large firms.
performed a research to find out, along with many two other research questions,
whether the factors which effect stock return in developed market also effects
the same in emerging markets and he deduced that all the factors are same and
the relation of stock return and size of the firm is negative. In contradiction
of above all studies (Lam, 2002) suggests that although size of the firm have
impact on the stock return but the relation between the two is positive.