Auditor specialization in R&D and clients’ R&D investment-q sensitivity

While research and development (R&D) activities contribute to economic growth via technological innovations, they impose significant uncertainty and agency costs. In this study, we examine the governance role of R&D specialist auditors in affecting clients’ R&D investment decisions. Using a sample of U.S. firms during 2001–2016, we find that R&D specialist auditors’ clients make more efficient investments in the form of a higher R&D investment-q sensitivity. We also find that the reduction in discretionary adjustments of R&D expenses moderates the results. Further, when clients are audited by R&D specialists, their R&D investments are more closely linked to innovative output in subsequent years. Collectively, our results suggest that an auditor’s specialized knowledge induces clients to make better economic decisions.     

The Effects of Private Investments in Public Equity on R&D Investment in Small and Medium-Size Enterprises

This paper provides evidence that small and medium-size enterprises (SMEs) use a portion of private investments in public equity (PIPEs) for current research and development (R&D) investment, hold the rest in liquidity reserves such as cash assets and working capital, and ultimately use these reserves to smooth R&D investment. That is, PIPEs may have a direct effect on R&D investment and an indirect or smoothing effect using liquidity reserves. This paper also shows that innovative SMEs such as venture businesses, inno-biz firms, and management innovative firms are more likely to use PIPEs for R&D investment than are noninnovative SMEs. The implications of this paper are that PIPEs can be used as an important source of external financing to fund R&D investment and can be particularly valuable for R&D investment in innovative SMEs.     

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.     

International Financial Reporting Standards and the value relevance of R&D expenditures: Pre and post IFRS analysis

This study examines the value relevance of research and development (R&D) expenditures in the pre and post International Financial Reporting Standards (IFRS) periods in the UK. It also examines firm size and sector-based differences in the value relevance of R&D during the sample period between 2001 and 2011. The results indicate that capitalized R&D has value relevance during the 11 years sample period. However, the value relevance of capitalized R&D does not appear to have improved in the post-IFRS period. Large firms present higher value relevance of capitalized R&D than small firms which suggest that firm size has significantly different valuation effects on the value relevance of R&D expenditures. Sectors, however, do not appear to present valuation differences across manufacturing and nonmanufacturing firms. The overall findings of this study report no difference in the value relevance of expensed R&D in the pre and post-IFRS periods; however, the value relevance of capitalized R&D appears to decrease from pre to post-IFRS period. We thus argue that these findings have implications for the regulators and accounting professionals.     

Innovative intensity and its impact on the performance of firms in Brazil

This article evaluates whether firms that invest in research and development (R&D) have better future performance and if stock market fully value such intangible investment. The results of annual cross-sectional regressions indicate a strong association between the intensity of R&D and future performance, even after controlling for other variables that affect future performance. However, after controlling for firm characteristics and risk factors, the innovative intensity was not significant in predicting future returns. In general, the results suggest that the R&D intensity is not useful for firm valuation in Brazil.     

Banks and innovation: Microeconometric evidence on Italian firms

In this paper we investigate the effect of local banking development on firms’ innovative activities, using a rich data set on innovation for a large number of Italian firms over the 1990s. There is evidence that banking development affects the probability of process innovation, particularly for firms in high-tech sectors, in sectors more dependent upon external finance, and for firms that are small. The evidence for product innovation is much weaker and not robust. There is also some evidence that banking development reduces the cash flow sensitivity of fixed investment spending, particularly for small firms, and that it increases the probability they will engage in R&D.     

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.     

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.     

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.     

Reliability of R&D capitalization: Evidence from ex post impairment in China

Unlike prior studies that investigate research and development (R&D) accounting as a dichotomous choice between capitalizing vs. expensing, this study identifies low-reliability R&D capitalization by the occurrence of ex post impairment of capitalized R&D costs. I find that low-reliability capitalization is associated with higher discretionary accruals but fails to signal future innovation, whereas normal capitalization without subsequent impairment lacks earnings aggressiveness and predicts future innovation positively, compared to expensing firms. Next, this study shows that Big 4 and industry specialist auditors improve reliability by notably decreasing the likelihood of low-reliability R&D capitalization. The results remain robust after controlling for R&D investment intensity and potential endogeneity in the capitalization decision. Additional tests show that managers strategically time the recognition of impairment for big-bath and earnings-smoothing purposes, and that analyst coverage does not help differentiate between low-reliability and normal R&D capitalization. Collectively, this paper increases our understanding of R&D accounting and auditing and contributes to the debate on the reliability of R&D capitalization.     

Public entrants,public equity finance and creative destruction

We explore the importance of new public firms and public equity finance for R&D and creative destruction in the US high-tech sector. Over 1900 new public firms enter high-tech manufacturing between 1970 and 2004; they are increasingly R&D intensive and rely extensively on public equity finance in the 1980s and 1990s. We estimate dynamic R&D models and find a strong link between public equity finance and R&D for new entrants, but not established entrants or incumbents. Further, recent cohorts of public entrants have a substantial economic impact: by 2000, recent public entrants account for almost half of high-tech sales and more than half of R&D. Variation in the availability of public equity finance has a marked impact on entrant R&D and the rate at which entrants take market share from incumbents. Our findings identify a key channel through which public equity markets facilitate the process of creative destruction.     

The impact of costly regulation on R&D investment levels and productivity

Prior research finds that risk-taking has declined after the Sarbanes-Oxley Act of 2002, consistent with the notion that SOX's corporate governance and internal control mandates diverted resources away from corporate risk-taking. We introduce to the accounting literature a new measure of R&D productivity, Research Quotient, to examine whether SOX affects R&D risk-taking and R&D productivity differently and whether the quality of the firm's governance and internal controls, pre-SOX, moderate these relations. While we find the relation between SOX and R&D risk-taking is sensitive to research design choices, we find a consistent positive relation between SOX and Research Quotient. Our evidence indicates that while firms may allocate fewer resources to R&D post-SOX, they concurrently manage their R&D investments more productively. Further, our results are robust to a difference-in-difference design and are stronger for firms with weaker governance pre-SOX.     

Shareholder governance, bondholder governance, and managerial risk-taking

We examine the relation between the overall corporate governance structure and managerial risk-taking behavior. We find that the overall governance structure has a significant impact on how managers make decisions on investment policy: strong bondholder governance motivates more low-risk investments such as capital expenditure and lower high-risk investments such as R&D expenditures, whereas weak shareholder governance (entrenched managers) leads to more R&D expenditures. Moreover, we find that the effects of governance on investment policy differ significantly between speculative and investment-grade firms. For speculative firms, strong bondholder or shareholder governance leads to more capital expenditures and low R&D investments. For investment-grade firms, strong bondholder or shareholder governance leads to low capital expenditures and an insignificant impact on R&D investments. Furthermore, financing and investment covenants exhibit strong binding power to deter risky investments. Finally, a more dependent (or a less independent) board is associated with low capital expenditures and high R&D investments.     

Can foreign suppliers act as “innovation springboards” for firms? Evidence from China

This study provides a new approach for measuring supplier characteristics by distinguishing the countries where they are located. Using data of Chinese listed companies, we explore how firms' R&D investment and innovation efficiency (patents and citations) are affected by having foreign suppliers in their top five suppliers. Our findings suggest that foreign suppliers acting as transmitters of international technology increase firms' innovation efficiency based on organizational learning theory. Moreover, a series of uncertainties caused by foreign suppliers encourages firms to invest more in R&D based on strategic growth option theory. Mechanism tests show that foreign suppliers from countries with high innovation capacity and a similar Eastern culture have a greater impact on corporate innovation. Firms conduct more R&D activities to mitigate the uncertainties caused by foreign suppliers when they have insufficient overseas channels to acquire international knowledge and a high degree of dependence on foreign suppliers. These results are consistent with a series of robustness tests after accounting for endogeneity.     

An exploration on policy uncertainty as a driver of R&D activity

We explore the relationship between uncertainty in economic policy and R&D activity for the sample of 576 firms from seven countries in the world. We base our analysis on an index of newspaper-based economic policy uncertainty (EPU) following the approach of Baker et al.’s (2016). We observe a significantly negative link between EPU and R&D intensity. Interestingly, the negative effect of policy uncertainty has less effect on the R&D activities of firms with growth opportunities. Finally, firms in politically sensitive industries respond stronger to EPU as far as R&D intensity is taken into account.     

R&D sensitivity to asset sale proceeds: New evidence on financing constraints and intangible investment

We examine the intersection between corporate divestitures of tangible assets and investment in intangible capital (R&D) to provide new tests for the impact financing constraints have on real activity. A positive R&D sensitivity to asset sale proceeds indicates binding financing constraints since cash inflows from tangible asset sales are negatively correlated with productivity shocks and not otherwise connected to intangible investment via non-financial channels. Using a variety of estimation approaches, we document a strong, positive link between cash inflows from fixed asset sales and corporate R&D investment, but only among firms most likely facing binding financing constraints. These results offer robust evidence that financing frictions impact the increasingly important yet understudied intangible corporate investments that drive innovative activity, and they highlight a previously unexplored but potentially valuable use of proceeds from fixed asset divestitures.     

Accounting choice and future performance: The case of R&D accounting in France

We examine whether managers’ decisions to capitalize or expense R&D expenditures convey information about the future performance of the firm. Focusing on a French setting where managers can choose to capitalize R&D expenditures under certain circumstances, we find that, after controlling for industry effects, firms that capitalize R&D expenditures spend less on R&D, have more volatile R&D efforts, and are smaller and more leveraged than firms that expense R&D expenditures. We also find that capitalizers capitalize R&D outlays when they need to meet or beat thresholds. Finally, we show that the decision to capitalize R&D is generally associated with a negative or neutral impact on future performance, even after controlling for self-selection. Our results also show that when firms both capitalize and expense R&D expenditures, the expensed portion exhibits a stronger (and negative) relationship with future performance. Market-based tests corroborate these findings. While we cannot unambiguously establish whether our findings imply that management uses R&D capitalization to manage earnings or because it is unable to estimate the earning power of R&D projects, our results suggest that management is unable to truthfully convey information about future performance through its decision to capitalize R&D. Our findings, based on real data as opposed to simulated data, therefore contrast with previous supportive evidence in favor of capitalization in the literature.     

The Impact of Corporate Diversification on the Long-Term Stock Return of R&D Increase Announcements

Prior studies have tested the long-term performance of research and development (R&D) spending, but the results are inconclusive. This study extends this line of research and explores the impact of corporate diversification on the long-term stock returns on R&D increase announcements. After controlling for the important variables in explaining the performance of R&D increases, a significantly negative association is found between the degree of corporate diversification and the long-run stock returns on R&D increase announcements. This result suggests that the costs of corporate diversification dominate the benefits regarding corporate diversification, and highlight the important effect a firm's diversification strategy has on the market valuation of R&D innovation.     

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.     

Government R&D spending,fiscal instruments and corporate technological innovation

Using panel data from 242 cities in China, we examine the impact of government research and development (R&D) spending on corporate technological innovation. We find that listed firms located in cities with higher government R&D expenditures are more innovative than firms in other cities. Further, the positive effect of government R&D spending depends on fiscal instruments and factor allocation. Through subsidies and tax incentives, government R&D spending enhances firm innovation by alleviating financing constraints, improving employee creativity and ensuring efficient operations. We demonstrate that subsidies are more effective than taxes in spurring corporate technological innovation. We also show that the impact of government R&D spending is stronger for state-owned and high-tech enterprises than for other enterprises. Overall, our findings suggest that government R&D spending can substantially improve corporate technological innovation through fiscal instruments.