Measuring Distress Risk: The Effect of R&D Intensity

Because of upward trends in research and development activity, accounting measures of financial distress have become less accurate. We document that (1) higher research and development spending increases the likelihood of misclassifying solvent firms, (2) adjusting for conservative accounting of research and development increases the number of correctly identified distressed firms, and (3) adjusted measures of distress alleviate previously documented anomalously low returns of large, high distress risk, low book‐to‐market firms. The results hold after updating stale parameters and under various tax assumptions. Our evidence raises concerns about interpretation of extant literature that relies on accounting measures of distress.     

R&D AND CAPITAL MARKETS

The substantial growth of R&D expenditures over the last two decades, together with the continuous substitution of knowledge (intangible) capital for physical (tangible) capital in corporate production functions, has elevated the importance of R&D in the performance of business enterprises. At the same time, however, the evaluation of corporate R&D activities by investors is seriously hampered by antiquated accounting rules and insufficient disclosure by corporations. Despite the fact that the expected benefits of R&D stretch over extended periods of time, corporate investments in R&D are immediately written off in financial reports, leaving no trace of R&D capital on balance sheets and causing material distortions of reported profitability. After a brief review of statistics documenting the growth and economic importance of corporate R&D in the U.S., the article presents a comparison of R&D disclosure regulations among industrialized nations that shows U.S. rules to be the least flexible in allowing management discretion in how they measure and report R&D. Next the author surveys the large and growing body of empirical research on R&D, which provides strong testimony to the substantial contribution of R&D to corporate productivity and shareholder value. Moreover, despite widespread allegations of stock market “short termism” throughout the 1980s and early '90s, the research indicates “unequivocally” that capital markets consider investments in R&D as a significant value-increasing activity. But if investors clearly demonstrate a willingness to take the long view of R&D, there is also evidence of undervaluation of some R&D-intensive companies—particularly those with low profitability—as well as other potential costs to corporations and investors stemming from inadequate public information about R&D. To help correct the reporting biases and distortions of R&D, the author offers some suggestions for investors and analysts that follow R&D-intensive companies. In particular, he proposes (1) adjustment of reported data to reflect the capitalization and amortization of (instead of expensing) corporate R&D and (2) the use of various quantitative measures for gauging research capabilities and output, including citations of the firm's patents and measures indicating the share of current revenues coming from products developed within recent years.     

R&D investment and systematic risk

The present study investigates the relationship between a firm's R&D intensity and the risk of its common stock, by analysing a sample of firms which are more profitable, larger in market capitalization and more R&D intensive than the universe of US‐listed firms. The results from the portfolio analysis, Monte Carlos simulations and correlation analysis of our sample show that: (i) R&D intensity is positively related to systematic risk in the stock market; (ii) the greater systematic risk is largely attributable to the greater intrinsic business risk and the greater operating risk of R&D‐intensive firms; (iii) R&D‐intensive firms carry marginally less financial leverage but they do not differ from other firms in terms of operating leverage; and (iv) our results are particularly strong in the manufacturing sector. For the non‐manufacturing sector, the results are not robust for different study periods.     

Exchange rate undervaluation and R&D activity

We examine how real exchange rate undervaluation policy affects research and development (R&D) activity. Using a panel data set comprising 49 developed and developing countries covering 1996–2011, we show that undervaluing the exchange rate retards technological innovation. Such a negative impact is particularly prominent for developed countries. This paper provides new insights into the real effects of undervaluation policy on the economy. An implication of our work is that countries implementing exchange rate undervaluation policy should be mindful of its potential negative effects on research and development activity.     

对央行数字货币研发的几点思考

近年来各主要国家和地区央行及货币当局均在对发行法定数字货币开展研究,市场上对央行数字货币利弊的讨论也在不断升温。央行数字货币具有传统货币无法比拟的优势,但风险也不容忽视。目前,数字人民币研发进展处于世界前列且受到国内外高度关注。在复杂的国际关系背景下,宜高度关注其潜在风险,有策略地推动数字人民币研发工作。     

R&D productivity following first-time CIO appointments

Prior studies find that firms announcing the appointment of a new chief information officer (CIO) are rewarded by stock price increases, suggesting that the market expects new CIOs to add longterm value to the firm. In this paper, we examine whether first-time CIO appointments result in improved R&D productivity. We focus on R&D investments because one role of IT management is to aid in discovery and management of growth opportunities. Successful R&D activities are designed to create the type of knowledge-based, growth-critical assets (new or improved products, better distribution methods, etc.) that effective IT management would be expected to assist. After controlling for industry performance, we find that the productivity of R&D improves significantly after the appointment of a new CIO for appointments before 1999 (1997–1998) but not for appointments in later years (1999–2007), and that productivity improvements over the entire sample period occur for CIO appointments by firms with superior IT capabilities. Our results for R&D investments suggest that new CIOs improve the way IT is managed and improve their firms' approach to knowledge management.     

The Relation Among Targets' R&D Activities, Acquirers' Returns, and In-Process R&D in the US

Abstract:  Using a sample of 129 mergers and acquisitions (M&As) in the US between publicly traded acquirers and targets in research and development (R&D) intensive industries over the period of 1994-2004 and a size- and industry-matched sample, we examine the relation among targets' R&D activities, the probability of acquirers' writing-off in-process R&D (IPRD), and acquirers' returns around the time of M&A announcements. We find that firms acquiring targets with higher R&D investments tend to write off some of the acquired R&D assets upon the completion of the M&As. We also find that the median cumulative abnormal return during the three days around M&A announcements for acquirers with subsequent IPRD write-offs is −2.73% while the return for acquirers without IPRD write-offs is −0.60%. This suggests that acquirers' stock returns around M&A announcements are much lower when investors expect acquirers to expense IPRD. The results are consistent with our conjecture that acquirers tend to write-off IPRD when they acquire overvalued targets. We also find that IPRD write-offs do not increase earnings or stock returns of acquirers after M&As, which is inconsistent with an earnings management hypothesis.     

Capitalizing R&D expenses versus disclosing intangible information

We study how to improve the value-relevance of financial information for intangible-intensive firms by investigating two alternatives: capitalizing research and development (R&D) expenses and disclosing intangible information. Using patent counts/citations to proxy for intangible intensity, we find that the incremental value-relevance of disclosing patent counts/citations is greater than that of capitalizing R&D expenses for the high-patent group and vice versa for the low- or medium-patent group. Investors favor the disclosure of patent information for firms with more successful innovations. Since disclosing intangible information may lead to appropriation by rivals, we find that, for the high-patent group, the incremental value-relevance of disclosing patent counts/citations is more pronounced for firms in industries with stronger protection of intellectual property. Overall, our results suggest that disclosing R&D outputs can improve the value-relevance of financial statements for firms rich in intangibles and the incremental benefits of such disclosure will be greater in industries with strong protection of intellectual property.     

R&D, knowledge spillovers and stock volatility

Firms improve their know‐how not only by innovations (producing new knowledge), but also by knowledge spillovers (learning from others). The objective of this study is to test for two major hypotheses developed from a theoretical model explaining the relationship between R&D, knowledge spillovers and stock volatility. Analytically, the model suggests that asymmetric information caused by R&D activities with uncertain future output increases stock volatility, even though dividends and consumptions remain unchanged. However, interfirm knowledge spillovers have a negative impact on stock volatility by reducing the degree of asymmetric information. Both hypotheses are supported by empirical evidence from this study.     

Environmental R&D and the uncertainty of future earnings

This paper examines whether the variability in the future earnings stream generated by the investment in environmentally-related R&D projects is different than that created by the investment in other R&D projects. To carry out this investigation, I decompose total R&D expenditures into two components: those related to R&D projects aimed at reducing the firm’s costs to comply with environmental legislation (i.e., the environmental component), and those related to all other R&D projects, which are focused on increasing the firm’s revenues and/or decreasing its other operating costs (i.e., the residual component). As predicted, I find that the environmental component of R&D expenditures contributes significantly less to the variability of future earnings than the residual component.     

R&D Investment timing,default and capital structure

Review of Quantitative Finance and Accounting - This paper investigates the interaction between R&D investment timing, probability of default, and capital structure. In particular we are...     

Information Asymmetry, R&D, and Insider Gains

Although researchers have documented gains from insider trading, the sources of private information leading to information asymmetry and insider gains have not been comprehensively investigated. We focus on research and development (R&D)—an increasingly important yet poorly disclosed productive input—as a potential source of insider gains. Our findings, for the period from 1985 to 1997 indicate that insider gains in R&D-intensive firms are substantially larger than insider gains in firms without R&D. Insiders also take advantage of information on planned changes in R&D budgets. R&D is thus a major contributor to information asymmetry and insider gains, raising issues concerning management compensation, incentives, and disclosure policies.     

R&D investments,capital expenditures,and earnings thresholds

Prior studies find that firms cut research and development (R&D) expense in response to earnings considerations. We extend this stream of research by documenting that firms narrowly achieving an earnings threshold also report unusually high capital expenditures. In addition, these firms’ total investments (R&D expense plus capital expenditures) do not vary in response to earnings thresholds, which suggests that, on average, reductions in R&D expense are offset by concurrent increases in capital expenditures. Lastly, our research design allows us to infer that the increased capital expenditures are largely R&D investments that are capitalized instead of non-R&D capital expenditures, suggesting that overall investments in R&D are relatively unchanged.     

Valuation implications of pharmaceutical companies' R&D regulatory approval notifications

This paper examines shareholder wealth effects surrounding applications to, and approvals by, the United States Food and Drug Administration (FDA) for firms listed on the New York (NYSE) and London (LSE) stock exchanges. Applications to the FDA for drug approvals significantly increase shareholder wealth for NYSE firms only. The increase is driven by applications for enhancements to existing drugs, with the market anticipating the application, thus suggesting information leakage. FDA approvals also significantly increase shareholder wealth in both markets. However, there is no evidence of information leakage and the significant post-event abnormal returns support the attention-grabbing hypothesis. Enhanced drug approvals are value-relevant for both markets, which highlights the contribution of real-options to firm value.     

Penetrating the Book-to-Market Black Box: The R&D Effect

The book-to-market (BM) phenomenon – the positive association between BM and subsequent returns – looms large among capital market enigmas. Economic theory postulates that the difference between market and book values of companies reflects their future abnormal profits. We capture these abnormal profits for a large sample of science-based companies by estimating the value of the off-balance sheet investment generating those profits – the value of R&D capital – and show empirically: (i) Firms' R&D capital is associated with their subsequent stock returns. (ii) For R&D intensive firms, this 'R&D effect' subsumes the 'book-to-market effect.' (iii) The association between R&D and subsequent returns appears to result from an extra-market risk factor inherent in R&D, rather than from stock mispricing. We thus provide an explanation for the book-to-market phenomenon of R&D companies.     

CEO risk incentives and firm performance following R&D increases

In this study we analyze how CEO risk incentives affect the efficiency of research and development (R&D) investments. We examine a sample of 843 cases in which firms increase their R&D investments by an economically significant amount over the period of 1995–2006. We find that firms with higher sensitivity of CEO compensation portfolio value to stock volatility (vega) are more likely to have large increases in R&D investments. More importantly, we find that high-vega firms experience lower abnormal stock returns and lower operating performance compared to their low-vega counterparts following the R&D increases. Our main results hold in a variety of robustness tests. The results are consistent with the conjecture that high-vega compensation portfolios may induce managers to overinvest in inefficient R&D projects and therefore hurt firm performance.     

Measuring tax incentives for R&;D

A methodology for measuring the user cost of intangible R&D capital is developed. In contrast to the way in which the Hall–Jorgenson–King–Fullerton (HJKF) approach to measuring the user cost of capital, and the related notion of the effective marginal tax rate on capital, is typically applied to intangible R&D capital, the methodology takes explicit account of the microeconomic foundations of R&D in order to aggregate the user costs of the various inputs used in the production of R&D. Illustrative calculations are presented for Canadian provinces which show that relative to the methodology developed here, the standard approach substantially overstates the tax subsidy offered to intangible R&D capital.      

The value relevance of R&D across profit and loss firms

We examine whether the valuation relevance of R&D documented for loss firms extends to profit firms. We use the residual-income valuation model and show that the valuation multiplier on R&D expenditures is likely to be negative (positive) for profit (loss) firms. This occurs because the linear information dynamics assumption of the residual-income model is more appropriate for profit firms than loss firms. Earnings of profit firms are likely to contain information on the future benefits of R&D activity, however, earnings of loss firms do not contain such information. The empirical evidence confirms our predictions for profit and loss firms. An important implication of our findings is that understanding the role of the R&D expense line item in valuation across firms and within firms, across time depends on whether the linear information dynamics assumption of the residual-income model is applicable for the sample of firms under investigation.     

Firm boundaries matter: Evidence from conglomerates and R&D activity

This paper examines the impact of the conglomerate form on the scale and novelty of corporate Research and Development (R&D) activity. I exploit a quasi-experiment involving failed mergers to generate exogenous variation in acquisition outcomes of target firms. A difference-in-differences estimation reveals that, relative to failed targets, firms acquired in diversifying mergers produce both a smaller number of innovations and also less-novel innovations, where innovations are measured using patent-based metrics. The treatment effect is amplified if the acquiring conglomerate operates a more active internal capital market and is largely driven by inventors becoming less productive after the merger rather than inventor exits. Concurrently, acquirers move R&D activity outside the boundary of the firm via the use of strategic alliances and joint ventures. There is complementary evidence that conglomerates with more novel R&D tend to operate with decentralized R&D budgets. These findings suggest that conglomerate organizational form affects the allocation and productivity of resources.