Growth Opportunities, Investment-Specific Technology Shocks and the Cross-Section of Expected Returns∗

The market value of a firm can be decomposed into two fundamental parts: the value of assets in place and the value of future growth opportunities. We propose a theoreticallymotivated procedure for measuring heterogeneity in growth opportunities across firms. We identify firms with high growth opportunities based on the covariance of their stock returns with the investment-specific productivity shock. We find that, empirically, our procedure is able to identify economically significant and theoretically consistent differences in firms’ investment behavior, as well as risk and risk premia in their stock returns. Our empirical findings are quantitatively consistent with a calibrated structural model of firms’ growth.