Negative investment returns in a developing market context

Abstract

The traditional asset-pricing models dominating extant literature have produced many empirical failures. These models are based on market-side variables, without incorporating the firm side. This research extends the nascent investment-based asset-pricing theory (IBAPT), which relates share return directly to firm characteristics and explains why share returns are lower for firms with a higher rate of investment. IBAPT was conceptualized using United States-developed data and there is debate about the significance of this phenomenon under developing market conditions. Undertaking such analysis in developing market contexts has been rendered problematic by the lack of adequate data and the high costs of assembling an analysis system to model the data. The researcher resolved these problems. This study builds on the IBAPT by drawing evidence from the high-risk, high-volatility and low-turnover South African developing market context, distinctly different from the US. It further extends the concept of firm investment in the IBAPT by examining the impact of previously un-studied investment variables. It found the relationship between firm investment (‘I’) and subsequent share return (‘R’) was related to investment and lag periods, uncovering a significant negative I–R relationship with optimised investment and lag periods in this context. The return premium associated with firm investment style was significantly higher than 100 random investment styles tested on the Johannesburg Stock Exchange. It found that the I–R relationship can be associated with abnormal effects in the market (value-versus-growth, size, equity issuance, debt-to-equity and profitability), also dependent on investment and lag periods. This work thus contributes to the development of IBAPT scholarship, and suggests that future studies should attend carefully to investment and lag period variables. At the practitioner level, the work enhances the utility of IBAPT in determining pricing and investment decisions for listed as well as private firms, since the valuation method does not require factors aggregated from the market.