book value (the value of its assets at the time they entered the balance sheet) to its market value. Several studies have found that, on average, companies that have high book-to-market ratios tend to earn excess returns over long periods, even after adjusting for the risks that are associated with beta. The discovery of this book-to-market effect has sparked a fierce debate among financial economists. All of them agree that some risks ought to carry greater re- wards. But they are now deeply divided over how risk should be measured. Some argue that since investors are rational, the book-to-market effect must be capturing an extra risk factor. They conclude, therefore, that managers should incorporate the book-to-market effect into their hurdle rates. They have labeled this alternative hurdle rate the "new estimator of expected return," or NEER. Other financial economists, however, dispute this ap- proach. Since there is no obvious extra risk associated with a high book-to-market ratio, they say, investors must be mistaken. Put simply, they are underpricing high book-to-market stocks, causing them to earn abnormally high returns. If managers of such firms try to exceed those inflated hurdle rates, they will forgo many prof- itable investments. With economists now at odds, what is a conscientious manager to do? In a new paper,* Jeremy Stein, an economist at the Massachusetts Institute of Technologys business school, offers a paradoxical answer. If investors are rational, then beta cannot be the only measure of risk, so managers should stop using it. Conversely, if investors are irrational, then beta is still the right measure in many cases. Mr. Stein argues that if beta captures an assets fundamental risk-that is, its contribution to the market baskets risk- then it will often make sense for managers to pay atten- tion to it, even if investors are somehow failing to. Often, but not always. At the heart of Mr. Steins argu- ment lies a crucial distinction-that between (a) boosting a firms long-term value and (b) trying to raise its share price. If investors are rational, these are the same thing: any decision that raises long-term value will instantly in- crease the share price as well. But if investors are making predictable mistakes, a manager must choose. For instance, if he wants to increase todays share price-perhaps because he wants to sell his shares, or to fend off a takeover attempt-he must usually stick with the NEER approach, accommodating investors misper- ceptions. But if he is interested in long-term value, he should usually continue to use beta. Showing a flair for marketing, Mr. Stein labels this far-sighted alternative to NEER the "fundamental asset risk"-or FAR-approach. Mr. Steins conclusions will no doubt irritate many company bosses, who are fond of denouncing their in- vestors myopia. They have resented the way in which CAPM-with its assumption of investor infallibility-has come to play an important role in boardroom decision- making. But it now appears that if they are right, and their investors are wrong, then those same far-sighted managers ought to be the CAPMs biggest fans.         *Jeremy Stein, "Rational Capital Budgeting in an Irrational World," The Journal of Business, October 1996. Source: "Tales from the FAR Side," The Economist, November 16, 1996, p. 8.