Intangible Investment, Displacement Risk, and the Value Discount

Composition matters. The composition of assets in place and growth opportunities affect risk premia. Firms with growth opportunities in the form of intangible investments exposed to displacement risk have larger expected returns than firms with growth opportunities in the form of tangible investments. I develop a production-based asset pricing model showing that a firm's exposures to priced productivity and displacement risk depend on multiple firm characteristics. None of these characteristics alone can capture the firm's total exposure. Empirically, intangible investment positively predicts returns, and firms undertaking more intangible investment are more exposed to proxies for displacement risk. I develop six proxies to measure displacement risk shocks: three based on sorting firms into portfolios and three based on aggregate variables. A portfolio double-sorted on two key firm characteristics, the book-to-market ratio (including intangible capital) and the difference between the intangible and tangible investment rates, produces large excess returns that existing models cannot explain. This double-sort can explain the decline of the Value Premium.