Intangible Assets and Cross-Sectional Stock Returns: Evidence from Structural Estimation∗

We augment a q-theory model with intangible assets where investments in intangible assets incur adjustment costs and the accumulation of intangible assets leads to investmentspecific technological change. The key parameters of the model are estimated using crosssectional return data and the Generalized Method of Moments (GMM). Our results show that the intangible-assets-augmented q-theory model explains significantly better the value premium and the return differences among firms with different R&D intensities than the q-theory model with only tangible assets. Adjustment cost is estimated to be convex in intangible investments and is a more important determinant of cross-sectional stock returns than the investment-specific technological change effect. The magnitude of the adjustment costs of intangible investments is much larger than that of tangible investments, implying higher difficulty of rapid accumulation of intangible assets compared to tangible assets. This finding indicates that having a superior history of investments in intangible asset is crucial for firms to sustain their comparative advantages and provides a rationale for the higher persistence of R&D investments than the persistence of tangible investments observed in the data. JEL Classification: G12, E21, D24, O31, O32 ∗We thank Po-Hsuan Hsu, Jianjun Miao and Lu Zhang for their valuable comments and the support of Hong Kong University of Science and Technology and University of Michigan. All remaining errors are our own. †Finance Department, Stephen M. Ross School of Business, University of Michigan, 701 Tappan Street, Ann Arbor, MI 48109; Tel: (734) 616-3248; Fax: (734) 936 0282; E-mail: [email protected]; http://webuser.bus.umich.edu/xuenanli/. ‡Finance Department, School of Business and Management, Hong Kong University of Science and Technology, The Clearwater Bay, Hong Kong; Tel: (852) 2358-7661; Fax: (852) 2358-1749; E-mail: [email protected]; http://www.bm.ust.hk/ fnliu/.