Unexpected Asset Growth,Overinvestment,and Stock Returns

Having started rather late, Chinese stock market is making rapid progress. With the increasing of the number of listed firms, Chinese stock market develops in a high speed; financing securitization becomes more and more obvious. Stock market has played an increasingly important role in the national economy. More and more, the rational allocation of resources depends on the price mechanism in the stock market. But a lot of empirical evidence shows that in reality the stock market doesn’t seem to play the function of resource allocation and there is certain deviation in the pricing of the actual investment activities. Firms with higher asset growth subsequently earn significantly lower returns, namely, there exists marked asset growth anomaly in Chinese stock market.Following Titman, Wei and Xie’s methodology, this paper uses the financial data and stock transaction data of the listed firms in the Shanghai Stock Exchange and Shenzhen Stock Exchange from1998to2010to examine the real explanation of the asset growth anomaly. Based on SAS, this paper uses Fama and Macbeth (1973) cross-sectional regression. Using total asset growth as our measure of investment, we decompose total asset growth into expected and unexpected components, where the expected component is estimated from the extended Tobin’s Q-theory of investment. We further distinguish firms with positive unexpected asset growth from those with negative unexpected asset growth and examine return patterns associated with these different types of asset growth. Specifically, the investment-return relation is examined after controlling for the well-documented firm characteristic risks and equity misevaluation.The empirical test on Chinese stock market shows that total asset growth has a significant negative effect on future stock returns and this negative effect remains even after controlling for systematic risk factors and equity misevaluation. In2006, the reform of shareholder structure resolved many problems existed in the stock market. The equity structure of listed companies has experienced huge change and the operation efficiency of the capital market is enhanced markedly. The decomposed research indicates that during1998and2005neither the unexpected component nor the expected component of asset growth has a significant effect on future stock returns. During2006and2010, after controlling for systematic risk factors and equity misevaluation, firms with unexpected asset growth subsequently earn significantly lower stock returns. The analysis further shows that the documented asset anomaly is confined only to firms with overinvestment. This result indicates that the asset anomaly in Chinese stock market can be explained by the overinvestment explanation. The inefficiency of overinvestment may adversely affect a firm’s future stock returns, while the inefficiency of underinvestment has no marked influence. The overinvestment explanation is of importance for several reasons. On the one hand, it provides investors with a basic investment strategy. On the other hand, it gives policy recommendations to the management of listed companies and the healthy development of the stock market.There are a lot of shortcomings in the article. The paper gives the overinvestment explanation to the asset anomaly of Chinese stock market, but doesn’t further study the causation of firms’overinvestment. Besides, the causation of asset growth anomaly in different industries is not same due to their unique investment characteristics, the paper doesn’t concern this. These parts need further studies.