The Present Value of Future Market Power

Abstract

This paper relates valuation ratios to future markups in a present-value framework for total firm assets. Expected future cash flows explain the majority of the cross-sectional variance of firms’ asset market-to-book ratio, while asset discount rates only account for a relatively small fraction, mirroring the decomposition of firm equity valuation ratios. We find that expected future markups are a key component of cash-flow news that explains more than a quarter of the cross-firm differences in asset market-to-book ratios by itself. Changes in asset valuation ratios strongly forecast future markup growth even after controlling for lagged markup growth. The forecasting result holds in the cross section of firms, in the aggregate time series, and is stable across industries. Asset prices encode important information about the future time path of market power.