Market Valuation of Intangible Asset: Evidence on SG&A Expenditure

Abstract

In this paper, we investigate the stock market valuation of the intangible asset created by selling, general, and administrative (SG&A) expenditure. Although GAAP requires immediate expensing of SG&A, prior studies show that current SG&A generates future economic benefits, suggesting that it creates an intangible asset. We find that the contemporaneous stock market seems to recognize some of the intangible asset value implicit in SG&A. Positive subsequent returns can be earned in firms with a high SG&A intangible asset value. These excess returns are more likely due to investor mispricing than to risk compensation. Furthermore, we find that both analysts' long-term growth forecast revisions and one-year-ahead forecast errors are positively associated with the future value created by current SG&A, indicating that analysts partially incorporate the intangible SG&A asset value into their forecasts. Overall, the evidence suggests that the capital market only partially recognizes the intangible asset value created by SG&A expenditure.

What's in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage

“…Columns 1 and 2 of Table 8 show a positive (negative) and significant relation between the cross‐section of stock returns and SG&A expenses (accruals), which is consistent with the literature (e.g., Sloan 1996; Eisfeldt and Papanikolaou 2013; Mashruwala, Rajgopal, and Shevlin 2006; Novy‐Marx 2013; Ball et al 2015; Banker et al 2019). The results also suggest that a hedge strategy that is long in high‐SG&A‐expenses (low‐accruals) stocks and short in low‐SG&A‐expenses (high‐accruals) stocks generates additional returns when the limits to arbitrage are more severe.…”

“…Second, we show that limits to arbitrage help explain the return predictability of SG&A expenses. This result is novel, as previous studies (e.g., Eisfeldt and Papanikolaou 2013; Ball et al 2015; Banker et al 2019) document the return predictability of SG&A expenses, but no study focuses on limits to arbitrage as the source of SG&A mispricing. Last, we find that the apparent mispricing of gross (cash‐based operating) profitability is actually an artifact of a high positive (negative) correlation with SG&A expenses (accruals).…”

“…Lev and Radhakrishnan (2005) argue that SG&A expenses represent organizational capital and significantly affect firm performance and value. Eisfeldt and Papanikolaou (2013) find a positive and significant relation between SG&A expenses and the cross‐section of stock returns, and Banker et al (2019) attribute this return predictability to mispricing of SG&A expenses. Cash‐based operating profitability removes accounting accruals from operating profitability (Ball et al 2016).…”

“…This finding suggests that high‐gross‐profit firms tend to have greater expenses related to promotion, selling, and delivering the firm's products and services, which is reflected in higher SG&A expenses for such firms. The positive correlation between gross profitability and SG&A expenses suggests that forming portfolios based on gross profitability would result in portfolios that appear to be sorted by SG&A expenses; both gross profitability (Novy‐Marx 2013) and SG&A expenses (Eisfeldt and Papanikolaou 2013; Banker et al 2019) are positively related to future stock returns. In contrast to gross profitability, neither the operating nor cash‐based operating profitability measure exhibits a monotonic association with SG&A expenses.…”

“…Recent studies document that SG&A expenses represent investments in organizational capital that affect stock returns and firm value (Lev and Radhakrishnan 2005; Anderson et al 2007; Eisfeldt and Papanikolaou 2013; Ball et al 2015). Banker et al (2019) find that SG&A expenses are mispriced and have return predictability in the cross‐section of stock returns. Furthermore, cash‐based operating profitability excludes accounting accruals from operating profit (Ball et al 2016).…”