Organization Capital and the Cross-Section of Expected Returns

Organization capital is a production factor that is embodied in the firm's key talent and has an efficiency that is firm specific. As a result, both shareholders and management have a claim on the cash flows accruing from organization capital. Because the division of rents between shareholders and key talent can systematically vary over time, shareholders investing in organization capital are exposed to additional risks. In our model, key talent can transfer a fraction of the firm's organization capital to a new enterprise, and the benefits of this reallocation vary systematically. This outside option determines the division of cash flows from organization capital between shareholders and key talent, and renders firms with high organization capital riskier. We construct a measure of organization capital based on readily available accounting data and find that firms with more organization capital relative to their industry peers outperform firms with less organization capital by 4.7% per year. This dispersion in risk premia is not explained by the CAPM, the Fama and French (1993) or Carhart (1997) models. Our model offers additional testable implications that are supported by the data.