Stock market undervaluation of resource redeployability

• Date: 01 April 2018
• Author: Arkadiy V. Sakhartov
• DOI: http://doi.org/10.1002/smj.2775
• Published date: 01 April 2018

RESEARCH ARTICLE

Stock market undervaluation of resource

redeployability

Arkadiy V. Sakhartov

Management Department, The Wharton School,

University of Pennsylvania, Philadelphia,

Pennsylvania

Correspondence

Arkadiy V. Sakhartov, Management Department,

The Wharton School, University of Pennsylvania,

2017 Steinberg Hall–Dietrich Hall, 3620 Locust

Walk, Philadelphia, PA 19104–6370.

Email: arkadiys@wharton.upenn.edu

Research Summary: Stock market undervaluation of

resources was often assumed to have strategic implica-

tions. Such undervaluation lets firms buy resources rela-

tively cheaply, but it can also constrain resource

deployment. This article shows that the option to rede-

ploy a firm’s resources to a new business can be underva-

lued in stock markets when investors face ambiguity

about that option due to uniqueness of redeployment. The

developed formal model derives conditions under which

stock markets undervalue resources. Those conditions are

summarized with an empirical operationalization that can

be tested with a broad range of strategic implications.

Besides, the model provides a more complete account of

resource redeployability by demonstrating the redeploy-

ability paradox. The paradox highlights that some deter-

minants of redeployability enhance undervaluation, while

simultaneously increasing objective value of redeployable

resources.

Managerial Summary: Stock markets can systematically

undervalue resources. On the one hand, such undervalua-

tion creates a profitable opportunity for a firm that needs

some resources for its growth and compares the option to

buy stock in another firm, whose resource are underva-

lued, with the option to build those resources internally.

On the other hand, such undervaluation poses limits to

resource deployment strategies of the undervalued firm.

When does such undervaluation occur? This study high-

lights one possible source for undervaluation, ambiguity

that is faced by stock market investors about the option

to redeploy a firm’s resources to a new business. The

study specifies conditions under which stock markets are

more likely to undervalue resources. The understanding

of those conditions can guide managers toward strategic

opportunities.

Received: 12 March 2017 Revised: 21 December 2017 Accepted: 22 December 2017 Published on: 20 February 2018

DOI: 10.1002/smj.2775

Strat Mgmt J. 2018;39:1059–1082. wileyonlinelibrary.com/journal/smj Copyright © 2018 John Wiley & Sons, Ltd. 1059

KEYWORDS

ambiguity, arbitrage, real options, resource

redeployability, resource valuation

1|INTRODUCTION

Strategic implications of stock market undervaluation of resources have long been considered by

researchers. On the one hand, such undervaluation was alleged to create a profitable opportunity for

a firm that needs resources for its growth and compares the option to buy stock in another firm,

which has those resources, with the option to build them internally. Both Keynes (1936) and

Penrose (1959) stressed stock market undervaluation as a key reason why resources could be bought

relatively cheaply.

1

Accordingly, Lev (1983) and Trautwein (1990), who audited merger motives,

found undervaluation of public targets to be a key motivation for corporate acquisitions. That ratio-

nale was also implied in studies of such specific decisions by corporate acquirers as the target choice

(De Bondt & Thompson, 1992; Yu, Umashankar, & Rao, 2016) and the bid premium (Laamanen,

2007; Varaiya, 1987). Besides, target underpricing was assumed to drive investment by private

equity firms that could detect undervalued public targets (Dittmar, Li, & Nain, 2012). Finally, stock

market undervaluation of targets was used to explain excess returns to acquirers who preempt the

bidding (Carow, Heron, & Saxton, 2004) and pay bid premiums (Antoniou & Zhao, 2007). On the

other hand, stock market undervaluation was argued to pose limits to a firm’s own resource deploy-

ment strategies. Thus, undervaluation of firms that depend on public equity was shown to add con-

straints on their investment (Baker, Stein, & Wurgler, 2003). Assuming such constraints,

undervalued public firms were argued to switch to private equity (Benner & Zenger, 2016; Folta &

Janney, 2004), to undertake divestitures (Feldman, 2014), and to improve communication of their

strategies to stock market analysts (Benner, 2007).

Despite the very broad appeal to the strategic implications of stock market undervaluation of

resources, there has been a very compelling objection to the idea that such undervaluation, even if it

existed, could be used strategically. Notably, although advocates of efficiency of stock markets “do

not argue that the market pricing is always perfect,”they consider stock markets “amazingly success-

ful devices for reflecting new information rapidly,”and thus eliminating any “predictable patterns”of

undervaluation and respective “profitable investment opportunities”(Malkiel, 2003, pp. 60–61).

2

The

doubt about the strategic use of stock market undervaluation of firms was shared even by strategy

1

In particular, Keynes (1936, p. 151) argued that “there is no sense in building up a new enterprise at a cost greater than that at which

a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant

sum, if it can be floated off on the Stock Exchange at an immediate profit.”Similarly, Penrose (2009, p. 225) reiterated: “An under-

valuation by the market of the shares of a firm may be another reason why a particular firm may be acquired relatively cheaply.…

The undervaluation of stock is apparently still of some importance as a factor promoting mergers in the United States.”

2

The quote from Malkiel (2003) characterizes the semistrong form of market efficiency that is maintained contemporarily and

demands that asset prices reflect all information available publicly. Because some information might not be available publicly, semi-

strong efficiency does not imply that assets are always priced correctly. Thus, an asset can be underpriced when significant positive

information about that asset is private. Hence, semistrong efficiency admits that investors who have private insights can earn abnor-

mal returns. While that form of efficiency is commonly implied in event studies of the strategic use of private insights

(e.g., Capron & Shen, 2007), advocates of semistrong efficiency (e.g., Malkiel, 2003) argue that such strategic use may not be sus-

tainable because results of the profitable deals quickly become public and eliminate the source for excess returns.

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