Associate Professor of Finance Andrea Eisfeldt and her co-author, Dimitris Papanikolaou of the Kellogg School of Management, received the 2013 Smith Breeden Prize (list coming soon). The Smith Breeden Prize is awarded to the best paper published in the renowned Journal of Finance and is presented at the annual American Finance Association meetings. This marks the second time Eisfeldt’s work has been recognized by the AFA; she previously received recognition for a distinguished paper in the Journal.
In their prize-winning paper, “Organization Capital and the Cross-section of Expected Returns,” Eisfeldt and Papanikolaou develop a model that analyzes the effect of organization capital on asset prices and argue that “shareholders consider firms with high levels of organization capital to be riskier than firms with more physical capital.” Organization capital, as defined in the paper, is “a production factor that is embodied in the firm’s key talent and has an efficiency that is firm specific.” In other words, organization capital constitutes the firm’s know-how; the labor related knowledge, talent, and processes that make the firm productive. This know-how resides in the firm’s key talent; an asset that ``walks out the door at the end of every day.’’ The paper is the first to measure how the value of organization capital manifests in a market sense.
Importantly, unlike physical capital, for example, land, machinery, or any hard asset, the company cannot own organization capital. The fact that companies are at risk of losing key employees whose presence contributes to that value implies that firms with high levels of organizational capital present a greater risk to shareholders and investors. “Tech companies are a great example of high organization capital firms,” says Eisfeldt. “we can all name several high profile tech firms whose value stems in a huge way from key company executives and developers whose departure could be devastating for the firm’s value.”
Since such firms are riskier investments, investors should expect a higher rate of return. Eisfeldt and Papanikolaou found that investors in such companies expect and receive 4.6 percent risk-adjusted excess returns. This is a large effect given that average excess returns on the overall market have averaged around 6% over a long time period.
Eisfeldt says she plans to continue her research into the implications of organizational capital and is joined in this pursuit by UCLA Anderson Professors Bhagwan Chowdhry, Bruce Carlin, Mark Garmaise and Hanno Lustig, all of whom have done research into this area. The implication of the research is significant as the companies of the future, such as those in the technology space, will only see their levels of organizational capital increase.
As to the award, Eisfeldt says, “It makes me feel even more excited about the research and grateful for a fantastic co-author. I think this work is important and it is also a lot of fun.”
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