Bekaert, Geert, Campbell R. Harvey, Christian T. Lundblad, and Stephan Siegel, “Stock Market Valuations across U.S. States” American Finance Association, 75th Annual Meeting, Boston (2015).

Purpose:  To show that state-specific regulatory environment affects valuation, and to estimate the marginal impact of regulation.

Findings:

• After controlling for leverage and earnings growth volatility, PE ratios vary across states within the same industry (segmentation).
• State-specific financial deregulation decrease segmentation.
• Increased labor laws increase segmentation.
• Higher state-specific unemployment is linked with higher segmentation.
• Higher population density is linked with lower segmentation.
• Segmentation has been decreasing since the mid-1970s.
• Distance between a given state’s capital and New York’s capital is a statistically significant, but economically small, determinant of segmentation

Methods:

• Calculate the absolute difference in P/E ratios between an industry in a given state and the same industry in New York (the financial center of the U.S.)
  • price data comes from CRSP, with earnings data from Compustat
  • noise biases the measure upwards, so the measure is smaller for years or states with smaller firms
• A state’s level of segmentation is given by the value-weighted sum of the measure for all industries in the state.
• Regress the segmentation measure on variables
  • difference in leverage between industries in the given state and the same industries in New York
  • difference in earnings growth
  • difference in return volatility
  • number of firms in the state
  • time
• Classify a number of regulation changes that were made during the time sample, and conduct difference in differences tests.