R&D expenditures and implied equity risk premiums

This study investigates the relationship between research and development (R&D) expenditures and risk premiums implied in the costs of equity capital. We posit that R&D expenditures represent an information risk factor resulting from both information asymmetry about R&D between investors and managers and low-quality R&D reporting that impairs the coordination between investors and managers with respect to managers’ investment decisions. Our results support our position by showing a positive association between R&D expenditures and implied equity risk premiums. From this research along with prior studies, investors can have better knowledge about the risky nature of R&D expenditures that drive up implied risk premiums and at the same time provide opportunities to earn excess returns in a short to long horizon. Accounting standard setters can benefit from this study’s findings that R&D expenditures represent an off-balance-sheet risk factor and thus warrant reconsidering SFAS No. 2 for potential capitalization of R&D expenditures.     

The value-relevance of R&D and advertising expenditures: Evidence from Korea

This study examines the value-relevance of R&D and advertising expenditures of Korean firms, using a regression model based on the Ohlson [Contemp. Account. Res. (1995) 661] equity-valuation framework. Results indicate that R&D expenditures are positively associated with stock price, suggesting that capitalizing R&D expenditures is appropriate. The association is stronger for the portion of R&D expenditures that is capitalized, rather than expensed, suggesting that investors agree with management that the capitalized expenditures represent greater future economic benefits. Investors also appear to interpret fully expensed R&D expenditures as positive net present-value investments, however, suggesting that these expenditure should also be capitalized. Additional results indicate that advertising expenditures are negatively associated with stock price, and the magnitude of this negative association is similar to the association between other expenses and stock price. These findings suggest that investors believe the economic benefits of advertising expenditures expire in the current period, similar to other expenses.     

How does the executive pay gap influence audit fees? The roles of R&D investment and institutional ownership

Using a sample of US firms from 2003–2014, this study examines how the executive pay gap affects audit fees for firms with different levels of R&D investment and institutional ownership. Consistent with managerial power theory, we find that the executive pay gap is positively associated with audit fees, and that the positive association is attenuated by intense R&D investment and higher institutional ownership. We also find that the executive pay gap more strongly affects audit fees after the passage of the 2010 Dodd–Frank Act and the PCAOB's 2012 call to identify the audit risk related to executive incentive compensation. Additional analyses show that the moderating effects of R&D investment and institutional ownership on the pay gap–audit fees association are not conditional on auditor tenure, but the moderating effect of institutional ownership is stronger for firms hiring specialist auditors. Collectively, our findings suggest that auditors consider the business context, such as innovation initiative and external monitoring, when assessing audit risk related to the executive pay gap.     

Earnings Variability and Disclosure of R&D: Evidence from Press Releases

This study explores press releases in the pharmaceutical industry to expand our understanding of how investments in R&D outlays influence uncertainty of future earnings. The findings make two contributions to the literature. First, they provide evidence that equal investments in different R&D ventures are associated with differential variability of future earnings. This result suggests that non‐financial information contained in press releases captures attributes of firm‐specific R&D investments that are not revealed through R&D expenditures reported in financial statements. Second, prior studies have indicated that investments in pharmaceutical R&D are associated with the highest variability of future earnings among all industries. The results, however, suggest that for a large class of low‐risk pharmaceutical R&D investments, the relative variability of future earnings is low and similar to that generated by capital expenditures. The findings hold when we control for endogeneity in voluntary disclosure of press releases.     

CEO Ownership and Discretionary Investments

Abstract:  This study investigates empirically the relationship between CEO ownership and discretionary investments such as R&D and capital expenditures. We assert that the under-investment problem is high for R&D-intensive projects, while the over-investment problem is high for capital expenditures because of differences in risk between the two types of investments. Building on the linkages between investments and investment-related agency problems, we hypothesize that the relationship between CEO ownership and investments depends on whether increasing ownership mitigates or exacerbates the under- or over-investment problem. We find a non-linear association between CEO stock ownership and R&D investments; R&D investments increase and then decline across increasing levels of ownership. Further, we find that R&D investments and CEO stock options are positively associated at high levels of option holdings. In contrast, capital expenditures do not vary with CEO ownership (stock or options). Finally, consistent with our underlying assumption, we find that the influence of R&D investments on future firm risk is significantly larger than that of capital expenditures. Our findings indicate that managerial risk aversion affects discretionary investments.     

CEO Overconfidence and Long‐Term Performance Following R&D Increases

We examine the relation between Chief Executive Officer (CEO) overconfidence and significant increases in research and development (R&D) expenditures. Although prior studies reveal a significantly positive market reaction to increases in R&D expenditures in both the long and short run, we find that long‐run stock performance is positive only for firms whose CEOs are not overconfident. Our findings, which may be attributable to overinvestment and the overestimation of future cash flows, imply that R&D resulting from overconfident behavior does not provide any value to firms.     

Pension accrual management and research and development investment

This study investigates whether discretion in reporting pension expenses mitigates research and development (R&D) manipulation. Using a sample of Japanese manufacturing firms during the fiscal years 2001–2011 where both pension costs and R&D expenditures have large impacts on the bottom‐line earnings, I find that higher discount rates are associated with higher R&D investment among firms in which pension expenses could have large impacts on reported earnings. I also find that this relationship is found only among firms in high‐tech industries. These results suggest that pension accrual management substitutes costly R&D manipulation that may hurt future competitive edge.     

Does the Riskiness of R&D Outweigh Its Benefits? The Perspective of US Private Lenders

We investigate the relationship between R&D investments and loan spread. Prior research documents that R&D is associated with greater future benefits and risks, suggesting that the valuation of R&D depends on a tradeoff between the two. Some research finds that bondholders consider that the benefits of R&D outweigh its risks: R&D is negatively associated with bond yields. This is surprising given that debt holders are more concerned about downside risk due to asymmetric payoffs. Using data on private debt from the US, we find an overall positive association between loan spread and R&D intensity, suggesting that the riskiness of R&D appears to outweigh its benefits for private lenders. Furthermore, an asymmetric payoff structure implies that the risks of R&D for lenders increase with default risk. Consistent with this argument, we find a positive association between R&D and loan spread for firms that are smaller, with high default‐risk ratings, unrated (no public debt), or in industries with weaker legal protection. Unrated firms are in the most R&D‐intensive group and make up nearly 60% of the firms with private debt. Consequently, studies that exclude unrated firms are likely to present an incomplete picture of the perspective of debt holders on R&D.     

The size,concentration and evolution of corporate R&D spending in U.S. firms from 1976 to 2010: Evidence and implications

The use of research and development (R&D) spending as an empirical proxy for managerial discretion, information asymmetry and growth opportunities, is pervasive in empirical corporate finance research. Underlying this is the implicit assumption that firms choose levels of R&D to maximize value, given firm and industry characteristics. An alternative framework views the level of R&D spending as subject to idiosyncratic behavior as managers myopically manipulate R&D expenditures to meet short-term earnings goals. Using aggregate firm and industry level data, we find evidence consistent with the view that R&D is determined by firm and industry characteristics. Time invariant firm and industry fixed effects explain most of the cross-sectional variation in observed R&D spending, while time-varying factors like size, profitability, or market-to-book explain little of the cross-sectional variation. We find that R&D spending continues to grow faster than advertising and capital expenditures. We also find no evidence of managerial myopia as corporate aggregate R&D expenditures are growing faster than aggregate profitability and the number of firms that undertake R&D has increased over the period from 1976 to 2010.     

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.     

Market Valuation of Successful versus Non‐successful R&D Efforts in the Pharmaceutical Industry

Abstract:   This paper examines the relationship between a non‐financial measure of successful research and development (R&D) efforts in the pharmaceutical industry and R&D expenditures. I hypothesize that the R&D of successful producers will be valued more by the market than the R&D of non‐successful producers. The regression results support the hypothesis. In the primary model, R&D is not associated with price; however, the coefficient on the interaction between R&D and successful developers is positively related to stock price. This implies that the market values the R&D expenditures of successful developers but not the expenditures of less‐successful developers.     

Investment policy in family controlled firms

We explore the relation between family ownership and corporate investment policy. Our analysis centers on two incentives, risk aversion and extended investment horizons, which potentially influence the level and type of investments that family firms undertake. We find that family firms devote less capital to long-term investments than firms with diffuse ownership structures. When dividing long-term investment into its two components of R&D and capital expenditures, we note that family firms, relative to nonfamily firms, prefer investing in physical assets relative to riskier R&D projects. Additional tests indicate that family firms receive fewer patent citations per dollar of R&D investment relative to nonfamily firms. Overall, all empirical results indicate that family preferences for lower firm risk, across all family sub-types, affects corporate R&D spending and capital expenditures.     

Equity compensation and the sensitivity of research and development to financial market frictions

When financial market frictions exist, executives may have to decide which investment activities to reduce when internal funds decrease. Expenditures on research and development (R&D) may be particularly vulnerable because of the long-term nature of innovative activity. We find that equity compensation is associated with lower levels of firm R&D expenditures. Rewarding executives to incur more risk has little effect on R&D expenditures, but rewarding executives for higher returns reduces R&D expenditures and makes R&D expenditures more sensitive to financial market frictions. In contrast, cash compensation reduces the sensitivity of R&D expenditures to financial market frictions.     

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.     

CEO compensation and performance in US private foundations

In a large sample of US private foundations, we examine the association between CEO compensation and an accounting‐based measure of performance, administrative efficiency. We document a positive pay–performance association across time within foundations, but a negative association across foundations. We interpret our evidence as follows: some foundation boards reward CEOs for high administrative efficiency, which results in a positive pay–performance association. However, some foundations are poorly monitored relative than others, resulting in higher CEO compensation and lower efficiency.     

The Association of R&D and Capital Expenditures with Subsequent Earnings Variability

Abstract:  We estimate the association of investments in R&D and in physical assets (CAPEX) with subsequent earnings variability. We estimate these relations in different time periods and across industries. We find that R&D contributes to subsequent earnings variability more than CAPEX only in relative R&D-intensive industries – industries in which R&D is relatively more intensive than physical capital. In physical assets-intensive industries, we do not find similar relations. The findings suggest that with respect to subsequent earnings variability, fundamental differences between investment information about R&D and CAPEX exist. However, they are mainly noticeable in firms that operate in relatively R&D-intensive industries. The evidence also suggests there was a shift in the relations between R&D and CAPEX over time. Our findings contribute to the debate on accounting for R&D expenditures.     

The Association Between Investment Opportunity Set Proxies and Realized Growth

Realized growth can be viewed as a proxy for the unobservable investment opportunity set (IOS) of the firm, and provides a benchmark against which IOS proxy variables can be compared. Results from such a comparison indicate that many of the variables from earlier studies, including book-to-market measures and capital expenditure to assets ratios are consistently correlated with subsequently realized growth. However, R&D intensity and E/P ratios do not exhibit any consistent association with subsequent growth indicating that they may not be valid IOS proxies.     

The Determinants and Value Relevance of the Choice of Accounting for Research and Development Expenditures in the United Kingdom

Abstract:  This paper investigates the determinants and value relevance implications of the accounting method choice for development expenditures for firms with research and development (R&D) programs in the United Kingdom (UK). Using a sample of 3,229 UK firm-year observations over the period 1996–2004, I find that the decision to expense versus capitalize development expenditures is influenced by earnings variability, earnings sign, firm size, R&D intensity, leverage, steady-state status of the firm's R&D program, and R&D program success. Additional results indicate that there is little difference in value relevance between reported and adjusted numbers for both the Expensers and the Capitalizers. The evidence in this paper suggests that managers choose the 'correct' method for accounting for R&D in order to best communicate the private information which they hold.     

All Guts,No Glory: Trading and Diversification among Online Investors

I explore cross‐sectional portfolio performance in a sample containing 324,736 transactions conducted by 16,831 Swedish investors at an Internet discount brokerage firm during the period May 1999 to March 2002. On average, investors hold undiversified portfolios, show a strong preference for risk, and trade aggressively. I measure performance using a panel data model, and explain the cross‐sectional variation using investors' turnover, portfolio size and degree of diversification. I find that turnover is harmful to performance due to fees, and is therefore more predominant among investors with small portfolios. I argue that the degree of diversification is a proxy for investor skill, and it has a separate and distinct positive effect on performance. Investors underperform the market by about 8.5% per year on average, of which half can be attributed to trading costs.     

The influence of culture and transparency on global research and development intensity: An overview across Europe

Culture and transparency can be described as a set of beliefs, norms, and actions, which drive the human action into innovativeness. Over the centuries, those pillars have driven individuals, groups, organizations, and nations, into the most complex networking schemes. It seems now unquestionable that those beliefs and policies, affect both private and public organizations, driving them across innovation wages in a more incremental or radical way. The dependent variable in this research (R&D) embodies the disbursements in research and development, carried out by business enterprise and public sector, and by education institutions. Thus, this research aims to mainly explore the effect of culture and transparency, as drivers of business attractiveness, on global R&D intensity. Using information from 31 European countries over the period 2010–2014, total R&D expenditures were regressed against several variables such as the Hofstede's cultural dimensions, the public sector transparency index, and other aggregated variables. Most of the theoretical assumptions are now supported by our empirical outcomes. Culture and transparency can act as attractiveness drivers, for business sector organizations and for other private and public institutions, toward the implementation of knowledge transformation mechanisms and intellectual capital achievements.