Abstract:We propose a theoretically motivated procedure for measuring heterogeneity in firms’ growth opportunities and document its empirical properties. The term “growth opportunities” refers to the component...We propose a theoretically motivated procedure for measuring heterogeneity in firms’ growth opportunities and document its empirical properties. The term “growth opportunities” refers to the component of a firm’s market value that cannot be attributed to its assets in place. This decomposition of firm value underpins many of the theoretical models describing cross-sectional differences in firms’ investment and stock return behavior. However, successful applications of such models depend on the quality of empirical measures of growth opportunities. Our procedure identifies economically significant differences in firms’ growth opportunities which are not captured by the commonly used empirical measures. We base our approach on a theoretical model incorporating investment specific productivity shocks and heterogenous firms. Productivity shocks in the capital goods sector account for a significant fraction of observed growth variability, according to the literature on the real determinants of economic growth (Jeremy Greenwood, Zvi Hercowitz and Per Krusell 1997, Jonas D. M. Fisher 2006). Greenwood, Hercowitz and Krusell (1997) show that, empirically, investment specific shocks are negatively correlated with aggregate investment, both at business cycle and lower frequencies. Our model predicts that the sensitivity of firm stock returns to investment specific productivity shocks (z-shocks) is greater for firms that derive Growth Opportunities and Technology ShocksRead More