The Stock Market Valuation of Research and Development Expenditures

We examine whether stock prices fully value firms' intangible assets, specifically research and development (R&D). Under current U.S. accounting standards, financial statements do not report intangible assets and R&D spending is expensed. Nonetheless, the average historical stock returns of firms doing R&D matches the returns of firms without R&D. However, the market is apparently too pessimistic about beaten-down R&D-intensive technology stocks' prospects. Companies with high R&D to equity market value (which tend to have poor past returns) earn large excess returns. A similar relation exists between advertising and stock returns. R&D intensity is positively associated with return volatility.     

Reliance on R&D Partnerships: The Influence of Short-Term R&D Bias and The Nature of Competition

Reports indicate that capital markets frequently focus on short-term corporate financial performance. Arguments suggest that the R&D projects of many firms are skewed towards short-term, low-risk projects with relatively modest expected benefits, reflecting both a response by companies to financial market pressure to maintain short-term returns and a short-term R&D bias. Anecdotal evidence suggests that one response to short-term R&D bias by firms is for them to seek R&D partnerships with customers and suppliers. A theory is developed which suggests that when firms compete on the basis of product costs, they are likely to seek partnerships with customers and suppliers in order to respond to short-term R&D pressures. In contrast, when competition is innovation-based, firms are unlikely to pursue R&D partnerships in response to short-term R&D bias. The results of an empirical study provide support for this proposition.     

Excess Returns to R&D-Intensive Firms

Recent studies indicate that both current R&D investment levels and current or recent changes in R&D investment are positively associated with subsequent excess (risk-adjusted) stock returns. The tentative explanation offered for these results is that shares of R&D-intensive firms are mispriced because investors fail to see through earnings distortions caused by conservative accounting for R&D costs. However, an alternative explanation is that conventional controls for risk do not completely capture the riskiness of R&D-intensive firms, causing measured excess returns for these firms to be biased upward. This study provides evidence useful for distinguishing between the mispricing and risk explanations for R&D-related excess returns. Overall, our empirical results suggest that the positive association between R&D investment levels and excess returns is more likely to result from failure to control adequately for risk than from mispricing. On the other hand, our results do not rule out the possibility of a second source of excess returns that are due to mispricing and that are associated with changes in the level of R&D investment.     

A resolution of the distress risk and leverage puzzles in the cross section of stock returns

We revisit findings that returns are negatively related to financial distress intensity and leverage. These are puzzles under frictionless capital markets assumptions but are consistent with optimizing firms that differ in their exposure to financial distress costs. Firms with high costs choose low leverage to avoid distress, but they retain exposure to the systematic risk of bearing such costs in low states. Empirical results are consistent with this explanation. The return premiums to low leverage and low distress are significant in raw returns, and even stronger in risk-adjusted returns. When in distress, low-leverage firms suffer more than high-leverage firms as measured by a deterioration in accounting operating performance and heightened exposure to systematic risk. The connection between return premiums and distress costs is apparent in subperiod evidence. Both are small or insignificant prior to 1980 and larger and significant thereafter.     

Stock price and systematic risk effects of discontinuation of corporate R&D programs

We extend the evidence on whether investors impound efficiently into stock prices new disclosures about corporate R&D programs. We find that firms that disclose the discontinuation of some of their R&D programs experience a significant negative announcement-period stock price response which is worse for growth stocks, for small-size firms, and for firms with low operating cash flow. We find no evidence that R&D discontinuing firms experience an event-induced change in their systematic risk. We find evidence of a one-year-long price reversal; however, it is not robust to controlling for possible risk dimensions for firms with R&D capital that the three-factor model does not capture. Evidently, investors' initial response at disclosures of discontinuation of corporate R&D programs is efficient.     

M&As performance in the European financial industry

This paper looks at the performance record of M&As that took place in the European Union financial industry in the period 1998–2002. First, the paper reports evidence on shareholder returns from the merger. Merger announcements implied positive excess returns to the shareholders of the target company around the date of the announcement, with a slight positive excess-return on the 3-months period prior to announcement. Returns to shareholders of the acquiring firms were essentially zero around announcement. One year after the announcement, excess returns were not significantly different from zero for both targets and acquirers. The paper also provides evidence on changes in the operating performance for the subsample of merges involving banks. M&As usually involved targets with lower operating performance than the average in their sector. The transaction resulted in significant improvements in the target banks performance beginning on average 2 years after the transaction was completed. Return on equity of the target companies increased by an average of 7%, and these firms also experience efficiency improvements.     

The effect of R&D on future returns and earnings forecasts

Prior studies attribute the future excess returns of research and development activity (R&D) firms to either compensation for increased risk or to mispricing. We suggest a third explanation and show that neither the level of R&D investment nor the change in R&D investment explains future returns. Rather, the positive future returns that prior studies attribute to R&D investment are actually due to the component of the R&D firm??s realized return that is unrelated to R&D investment but present in R&D firms. Our results suggest that the excess returns of R&D firms are part of the larger value/growth anomaly. In addition, we show that while future earnings are positively associated with current R&D, errors in earnings expectations by investors and analysts are not related to R&D investment.     

The Stock Market and Corporate Investment: A Test of Catering Theory

We test a catering theory describing how stock market mispricingmight influence individual firms' investment decisions. We usediscretionary accruals as our proxy for mispricing. We finda positive relation between abnormal investment and discretionaryaccruals; that abnormal investment is more sensitive to discretionaryaccruals for firms with higher R&D intensity (opaque firms)or share turnover (firms with shorter shareholder horizons);that firms with high abnormal investment subsequently have lowstock returns; and that the larger the relative price premium,the stronger the abnormal return predictability. We show thatpatterns in abnormal returns are stronger for firms with higherR&D intensity or share turnover.     

Mispricing and risk of R&D investment in European firms

We study whether R&D-intensive firms earn superior stock returns compared to matched size and book-to-market portfolios across several financial markets in Europe. Mispricing can arise if investors are not able to correctly estimate the long-term benefits of R&D investment or whether R&D firms are more risky than others. The results confirm that more innovative firms can earn future excess returns. Stocks listed on continental Europe markets and operating in high-tech sectors are more prone to undervaluation. This can be caused in the first case by information asymmetries that are more severe in bank-based countries. No evidence is found for a different risk pattern of R&D-intensive stocks.     

Mispricing of Research and Development Investments in a Rapidly Emerging and Electronics-Dominated Market

This paper documents prevailing mispricing of research and development (R&D) investments in the Taiwan stock market, a rapidly emerging and electronics-dominated market. Applying stock return data from July 1988 to June 2005, we observe that R&D-intensive stocks tend to outperform stocks with little or no R&D. The R&D-intensity effect cannot be attributed fully to firm size and seasonal effects. The R&D-associated anomaly not only exists but also persists for up to three years. The market apparently undervalues R&D-intensive firms and overvalues non-R&D-intensive firms. Finally, the R&D anomaly is clearer for firms in the electronics industry after 1996.     

The valuation of R&D expenditures in Japan

The difficulty to measure the long‐term benefits of R&D expenditures and the distortions induced by R&D accounting suggest that R&D‐intensive firms could be undervalued. Using several methods commonly applied to detect the abnormal returns associated with mispricing, we find little evidence that the value of R&D investments has been underestimated in the Japanese stock market. Given that R&D accounting rules in Japan are similar to those in United States, the results appear to reject the hypothesis that accounting biases are the cause of the undervaluation of R&D investments observed in the United States.     

Separating Winners from Losers among LowBook-to-Market Stocks using Financial Statement Analysis

This paper combines traditional fundamentals, such as earnings and cash flows, with measures tailored for growth firms, such as earnings stability, growth stability and intensity of R&D, capital expenditure and advertising, to create an index – GSCORE. A long–short strategy based on GSCORE earns significant excess returns, though most of the returns come from the short side. Results are robust in partitions of size, analyst following and liquidity and persist after controlling for momentum, book-to-market, accruals and size. High GSCORE firms have greater market reaction and analyst forecast surprises with respect to future earnings announcements. Further, the results are inconsistent with a risk-based explanation as returns are positive in most years, and firms with lower risk earn higher returns. Finally, a contextual approach towards fundamental analysis works best, with traditional analysis appropriate for high BM stocks and growth oriented fundamental analysis appropriate for low BM stocks.This revised version was published online in August 2005 with a corrected cover date.     

Family friendly firms: does it pay to care?

In this paper we examine the returns to a portfolio of 29 firms that are perceived as family-oriented. The sample is based on firms awarded the best 100 companies for working mothers in Working Mother Magazine’s annual survey. There is much anecdotal evidence supporting the benefits of these programs, but little evidence relating family-oriented policies to shareholder wealth. We find, based on raw returns, that family-friendly firms do not earn statistically significant excess returns relative to a matched sample or to the S & P 500. Based on risk-adjusted returns, the family-friendly portfolio outperforms the market, but underperforms a matched sample portfolio.     

Asymmetric mean-reversion and contrarian profits: ANST-GARCH approach

This paper investigates the time-series evidence of asymmetric reverting patterns in stock returns that is attributable to “contrarian profitability.” Using asymmetric nonlinear smooth-transition (ANST) GARCH(M) models, we find that, for monthly excess returns of US market indexes over the period of 1926:01–1997:12, negative returns on average reverted more quickly, with a greater reverting magnitude, to positive returns than positive returns revert to negative returns. The results are quite consistent when the models are implemented not only for the different sample periods, such as 1926:01–1987:09 and 1947:01–1997:12, but also for portfolios with different characteristics, such as different firm-size portfolios and Fama–French risk-adjusted factor portfolios. We interpret the asymmetrical reversion as evidence of stock market overreaction.     

If It's Good for the Firm,It's Good for Me: Insider Trading and Repurchases Motivated by Undervaluation

My findings suggest that information inherent in insider trading can be used to identify undervalued repurchasing firms. I examine the relation between insider trading and the performance of open market repurchase (OMR) firms. I show that firms with high net insider buying prior to OMR announcements not only earn abnormal stock returns in both the short‐ and long‐run, but also exhibit better operating performance. Overall, the evidence is consistent with insiders timing their trades prior to OMR announcements.     

The valuation-relevance of the foreign translation adjustment: The effect of barriers to entry

We examine the economic effects of barriers to entry on the association between foreign currency translation adjustments and the stock returns of multinational firms operating in the manufacturing and service industries. Firms that are innovation leaders, that is, firms that are research and development (R&D) intensive and firms with high foreign asset intensity (i.e., asset-intensive firms), are our proxies for firms operating in environments with barriers to entry (i.e., environments in which competition is less intense). We hypothesize and find that foreign currency translation adjustments are positively associated with abnormal stock returns for firms operating in environments with barriers to entry in both manufacturing and service industries. This finding highlights the importance of assessing the valuation-relevance of foreign currency translation adjustments by considering the economic contexts of foreign currency movements. Overall, the evidence shows that the accounting rules governing foreign currency translations generally produce results consistent with the economic effects of foreign exchange rate changes.     

The relation between R&;D intensity and future market returns: does expensing versus capitalization matter?

The Australian accounting environment provides an ideal setting for examining the impact of different accounting treatments of firms’ R&D activities on their subsequent returns. Unlike US firms, which can only expense R&D, Australian GAAP permits firms to either expense or capitalize their R&D expenditure. We examine separately the market impact of the R&D intensity of all R&D active firms, ‘capitalizers’ and ‘expensers’. Our results suggest that firms with higher R&D intensity perform better, regardless of the accounting method used, consistent with the resource-based view of the firm. We also find some evidence that firms which expense R&D outperform those which capitalize R&D after controlling for R&D intensity.

The Impact of Strategic Investment Choices on Post-Issue Operating Performance and Survival of US IPO Firms

Abstract:  We examine the impact of strategic investment choices at the time of the IPO on: (i) the post-issue operating performance and (ii) the likelihood of failure and time-to-failure of newly public US firms. Our post-issue operating performance analysis uses various performance metrics, benchmarks, and expectation models. Overall, our evidence indicates that the extent of diversification and industry-adjusted capital expenditures intensity are generally positively related to changes in operating performance. We do not, however, document a consistent relation between industry-adjusted R&D expenditures and changes in operating performance. The results from our survival analysis suggest that pre-issue managerial commitment to R&D spending and developing diversified product lines enhance the ability of IPO issuing firms to remain viable for longer periods of time. Our study highlights the impact of various managerial investment decisions on the subsequent performance of newly public firms.     

Alpha and Persistence in Real Estate Fund Performance

This paper investigates whether fund managers investing in the direct real estate market can systematically and persistently deliver superior risk-adjusted returns. The research that has been published has typically focused on the performance of managers trading public real estate securities. Our study draws on a unique data set of commercial real estate funds collated by the Investment Property Databank (IPD) in the United Kingdom, covering up to 280 funds over the period 1981 to 2006. The widespread finding is that very few managers appear to be able to generate excess risk-adjusted returns. Furthermore, there is little evidence of performance persistence in either fund returns or risk-adjusted fund returns.     

Scale effects of R&D as reflected in earnings and returns

Using returns to scale as a conceptual foundation, we explore how R&D-related earnings performance and earnings variability depend upon firm size. We find that the positive association between the level of future earnings and R&D intensity increases with firm size, and that the positive association between the volatility of future earnings and R&D intensity decreases with firm size, consistent with R&D productivity increasing with scale. We also show that R&D scale is associated with lower market returns, consistent with the idea that R&D investment risk declines with scale.