Exploring an efficient investment regime: The case of SP100 companies

We explore whether there exists an efficient investment regime for a panel of SP100 companies over the period 1986-2007. We demonstrate that abnormal stock returns are related to corporate total assets growth rate (a proxy variable for exercising real investment options through contraction, abandonment or expansion), change in EPS (a proxy variable for the change in profitability after exercising investment options), and one-year lagged P/B ratio (a proxy variable for the value factor), conditional on one-year lagged market-to-book assets ratio (MBA ratio, a proxy variable for the level of investment opportunity). We utilize the panel smooth transition regression (PSTR) model to examine the threshold effect of one-year lagged MBA ratio on abnormal stock returns. We find that there exists an efficient investment regime between two threshold values of 0.4773 and 3.2728. Our results are robust to predict, approximately 74.42%, the movement direction of abnormal stock returns in year 2008. Therefore, the main contribution of this paper is that the CEOs of SP100 companies are able to exercise investment options to create value for their firms if their levels of the investment opportunity are in the efficient investment regime.