The Determinants of Investor Valuation of R&D Expenditure in the Software Industry

This paper examines the cross-sectional variability in the market valuation of R&D expenditures in the pre-packaged computer software industry. Consistent with some prior research, this paper argues that R&D spending is valued heterogeneously by the stock market, and derives hypotheses regarding the determinants of the cross-sectional heterogeneity in the market valuation of R&D. The empirical tests use an extensive database containing product level information of software firms between 1994 and 1998, along with accounting and stock price data of the same period. The test results, consistent with our hypotheses, show that R&D spending is more valuable for firms with larger market shares, higher percentage of technical employees, and those that have diversified into different product categories. The results also indicate that market valuation of R&D spending is a function of product life cycle.     

The stock market valuation of human capital creation

We develop a measure of firm-year-specific human capital investment from publicly disclosed personnel expenses (PE) and examine the stock market valuation of this investment. Measuring the future value of PE (PEFV) based on the relation between lagged PE and current operating income, we first show that PEFV is positively associated with characteristics of human-capital-intensive firms. Next, we find that PEFV has a positive pricing coefficient, implying that the market recognizes some of its variation. In our main analysis, we find that market participants fail to fully impound the investment in human capital. The absolute value of analyst forecast errors is increasing in firm PEFV, and the signed value of these errors reveals that analysts are pessimistic for earnings of firms with high human capital investments. A long-short portfolio based on PEFV produces annualized value-weighted (equal-weighted) abnormal returns of 6.5% (3.5%). Portfolios formed by interacting PEFV with total PE, which combines the current potential investment in human capital with the historic portion of PE that created human capital, increase these returns to between 4.8% and 7.8%. These results are insensitive to numerous empirical choices.     

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.     

The valuation relevance of R&D expenditures: Time series evidence

The literature on the valuation relevance of R&D investments is based primarily on cross-sectional regressions or panel data regressions with time and firm (or industry) fixed effects such that the parameters relating R&D to market value are cross-sectionally constant. In an alternative approach, this paper investigates the value relevance of R&D investment using an earnings-based time series valuation model. Model parameters are estimated for each firm separately. In contradistinction to the results obtained from cross-sectional and fixed effects panel models, this study finds weak empirical support at best for the value relevance of R&D expenditures at the firm level.     

R&D Increases and Long‐Term Performance of Rivals

We examine how a firm's research and development (R&D) increases affect its intra‐industry competitors in the long run. Consistent with the R&D spillover hypothesis, when a firm unexpectedly increases its R&D spending, its intra‐industry competitors experience improvements in operating performance and analyst forecast revisions and earn positive abnormal stock returns in the long run. The industry concentration, which is related to the firm's strategic reaction, is crucial in determining the magnitude of the R&D spillover effect.     

Equity valuation in practice: The influence of net financial expenses

This study investigates the relevance of net financial expenses with respect to equity valuation in an IFRS accounting regime. According to the residual earnings valuation model, income related to balance sheet items that are recorded at fair value is not applicable for valuation purposes. There are no residual earnings associated with these items because the balance sheet provides ‘perfect’ value estimates for the items in question. In accordance with the contention that under IFRS, aggregate net financial liabilities are recorded at a book value that is close to fair value, this study demonstrates that net financial expenses are not associated with the market prices of stocks. The investigation discusses the empirical findings in light of the enduring controversies regarding the use of fair value accounting.     

Market Valuation of Research and Development Spending under Canadian GAAP*

Section 3450 of the Canadian Institute of Chartered Accountants (CICA) Handbook requires Canadian firms to capitalize development costs that meet certain criteria and to expense those that relate to research. International Accounting Standard (IAS) No. 38 favours a similar approach. In the United States, Statement of Financial Accounting Standard (SFAS) No. 2 recommends the immediate expensing of all research and development (R&D) spending. The only exception is SFAS No. 86, which requires software development costs to be capitalized when a product successfully passes a technological feasibility test. Consequently, the Canadian financial disclosure regime provides a rich setting for testing the market valuation of capitalized R&D. Our primary research question asks whether capitalized R&D provides useful information to market participants investing in Canadian firms. We use price‐level and return models to assess the value relevance of capitalized R&D disclosed in the financial statements under Canadian GAAP. In line with expectations, using a price‐level model, we find that capitalized R&D and R&D expense as disclosed in the financial statements provide information that is value relevant to market participants. However, we find that R&D capitalized during the year helps explain returns while R&D expense does not. Thus we conclude that the application of section 3450 of the CICA Handbook produces value‐relevant information.     

Private placements of convertible securities: stock returns,operating performance and abnormal accruals

This study examines long‐run stock returns, operating performance and abnormal accruals of private placements of convertible securities. We investigate the effects surrounding private placements to test and differentiate the implications of several competing hypotheses. While the monitoring and certification hypotheses suggest positive effects, the managerial entrenchment, overvaluation and windows‐of‐opportunity hypotheses suggest the opposite. We find that placing firms generally experience positive effects in the pre‐periods and negative effects in the post‐periods. Our overall findings are more consistent with the predictions of the overvaluation and windows‐of‐opportunity hypotheses while our post‐placement evidence is also consistent with the predictions of the managerial entrenchment hypothesis.     

Game changer? The impact of the VW emission-cheating scandal on the interrelation between large automakers’ equity and credit markets

This paper investigates the change in the securities market pricing behavior of 16 large, global automakers following disclosure of the Volkswagen (VW) emission-cheating scandal on September 18, 2015, when the EPA issued a notice of violation to VW, stating that VW had intentionally circumvented the US clean air rules for diesel automobile emissions. We contend that this event unblocked an informational cascade, in that much of the information was already known to outside parties, yet no significant market response occurred until the September 18 EPA notice. We also find a significant change in the evolution of equity and credit default swap (CDS) prices in the automobile industry consistent with more-informed trading in the equity market. A test of economic significance further supports this finding by showing a decrease in the profitability of a trading rule based on a predictive relation between CDS spread changes and lagged equity returns.     

The information content of cash dividend announcements in a unique environment

Due to its distinctive institutional background, Oman offers a valuable opportunity to examine stock price reactions to dividend announcements. In Oman, (1) there are no taxes on dividends and capital gains, (2) there is a high concentration of share ownership, (3) there is low corporate transparency, and (4) firms frequently change their dividends. Our results show that announcements of dividend increases are associated with increased stock prices, while announcements of dividend decreases cause decreases in stock prices. Firms that do not change their dividends experience insignificant negative returns. These results contradict tax-based signaling models, which argue that higher taxes on dividends relative to capital gains are a necessary condition for dividends to be informative.     

The evolution of China’s banking system: bank loan announcements 1996–2009

This study investigates China’s evolving banking systems from 1996 to 2009 by testing the market response to bank loan announcements in the China. The results show a significant negative market response to bank loan announcements in the Chinese financial market for the sample period 1996–2004. However, after a series of reforms in the Chinese banking system, the significantly negative market response to bank loan announcements disappears for the sample period 2005–2009.     

The effects of information disclosure regulation on stock markets: Evidence from Vietnam

This paper investigates the effects of regulation pertaining to information disclosure on the Vietnam stock market. Using the event study methodology, we examine sectoral reactions, in terms of risk and return, following the announcements on information disclosure regulation in Vietnam. To validate the results, we also conduct several robustness tests such as the removal of firm-specific information and the use of a wide variety of ARCH models such as GARCH (1,1). We find evidence indicating that when the market anticipates a piece of regulation on information disclosure, most sectors experience negative reactions two and five days before the first announcement. Positive reactions are observed on the event date, as well as two and five days afterwards. Furthermore, we document a difference between the Ho Chi Minh Stock Exchange (HOSE) and the Hanoi Stock Exchange (HNX) in terms of market reaction. The results also show that the sectors experience changes in short-term systematic risk. Our contributions to the literature are threefold. First, we focus on a complete and more updated set of the Vietnam stock market’s information disclosure regulation. Second, our study examines the effects of a series of events on a single regulation at sectoral and firm levels in an emerging market. Third, in addition to sectoral analysis, we analyse the Vietnam stock market reaction at the firm level.     

Resilience and wellbeing in the midst of the COVID-19 pandemic: The role of financial literacy

Using the 2021 wave of the TIAA Institute-GFLEC Personal Finance Index (P-Fin Index), this paper provides an in-depth examination of the financial literacy of U.S. adults in the midst of the COVID-19 pandemic. Knowledge is troublingly low, with U.S. adults averaging a score of 50 percent on the twenty-eight questions that compose the P-Fin Index. Even more disturbingly, only 28 percent of U.S. adults correctly answered a question testing their ability to comprehend and compare probabilities. Financial literacy matters. Lower financial literacy is associated with increased time spent worrying about personal finances. After controlling for income, education, and key demographic information, the more financially literate are found to be more likely to be financially resilient, to plan for retirement, and to feel unconstrained by debt. These findings highlight the importance of financial knowledge, in particular in a time of crisis, and raise concerns about the public’s ability to comprehend complex messages about risk during the pandemic.     

The relationship between the frequency of news release and the information asymmetry: The role of uninformed trading

This paper shows that the degree of information asymmetry is lower for firms with more frequent news releases. The relation holds for various measures of information asymmetry such as the probability of information-based trading (PIN), permanent price impact, and adverse selection component of bid-ask spread, even after adjusting for endogeneity between news release and information asymmetry. By decomposing the PIN into intensities of uninformed and informed trades, similarly to Brown and Hillegeist (2007), we find that intensity of uninformed trading increases much more than that of informed trading for firms with more frequent news releases. As a result, information asymmetry, as is measured by PIN, decreases for such firms due to the large increase in the intensity of uninformed trading. Our findings highlight not only the importance of news releases in leveling the playing field of investors but also the role of uninformed investors in reducing trading cost due to information asymmetry.     

Detecting insider trading: The theory and validation in Korea Exchange

This paper provides an empirical basis for identifying insider transactions by deriving a theoretical model, which incorporates the relationship between insider transactions and time series of stock returns. Thus, this model enables us detecting insider transactions by applying stock return time series. We show that when there is an insider transaction in the market, time series can be derived as an ARMA(1,1) process having closed solution coefficients. For validation of the model, we test publicly released insider transactions and reverse takeover events using the minute-by-minute stock price data. The selected events show higher pass rate of the detection criteria than the current detection system which shows that our model produces smaller Type II error than the existing post transaction-based cumulative abnormal return model.     

The strategic specialist and imperfect competition in a limit order market

The empirical literature suggests that the limit order book contains information that might be used by the specialist to his own advantage. I develop a model where there is a strategic specialist who competes against a limit order book and has information about supply. The presence of a strategic specialist in an imperfectly competitive limit order book market induces non-monotonicity of market indicators with respect to the variance of liquidation value. Moreover, the existence of private information about supply significantly affects market performance as it induces, among other effects, lower market liquidity. Finally, this model suggests another link between Kyle’s (1985, 1989) [Kyle, A., 1985. Continuous auctions and insider trading. Econometrica 53, 1315–1336, Kyle, A., 1989. Informed speculators with imperfect competition. Review of Economic Studies 56, 317–356] and Glosten and Milgrom’s (1985) [Glosten, L., Milgrom, P., 1985. Bid, ask and transaction prices in a specialist market with heterogeneously informed markets. Journal of Financial Economics 14, 71–100] models by allowing for strategic behaviour of the specialist.     

The Internationalisation of UK R&D

Policies to promote research and development (R&D) are high on the government's agenda. R&D and innovation are seen as key drivers of economic growth and important for raising UK productivity. This paper considers recent trends in UK R&D performance. We show that UK R&D is more internationalised than that of other G5 countries and is becoming increasingly so at a faster rate. A rising share of UK R&D is funded from abroad and UK firms are undertaking more of their R&D overseas. Using an international panel of countries, we show that R&D in one country responds to a change in the price in another ‘competitor’ country. This suggests that UK innovation policies could play an important role in determining whether increasingly footloose R&D locates in the UK or moves overseas.     

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.     

Valuation in US Commercial Real Estate

We consider a log‐linearized version of a discounted rents model to price commercial real estate as an alternative to traditional hedonic models. First, we verify a key implication of the model, namely, that cap rates forecast commercial real estate returns. We do this using two different methodologies: time series regressions of 21 US metropolitan areas and mixed data sampling (MIDAS) regressions with aggregate REIT returns. Both approaches confirm that the cap rate is related to fluctuations in future returns. We also investigate the provenance of the predictability. Based on the model, we decompose fluctuations in the cap rate into three parts: (i) local state variables (demographic and local economic variables); (ii) growth in rents; and (iii) an orthogonal part. About 30% of the fluctuation in the cap rate is explained by the local state variables and the growth in rents. We use the cap rate decomposition into our predictive regression and find a positive relation between fluctuations in economic conditions and future returns. However, a larger and significant part of the cap rate predictability is due to the orthogonal part, which is unrelated to fundamentals. This implies that economic conditions, which are also used in hedonic pricing of real estate, cannot fully account for future movements in returns. We conclude that commercial real estate prices are better modelled as financial assets and that the discounted rent model might be more suitable than traditional hedonic models, at least at an aggregate level.     

Short-selling activities in the time of COVID-19

This study examines the daily short-selling activities in the U.S. market during the early 2020 outbreak of the COVID-19 global pandemic. Our findings indicate firms that are more sensitive to the shock (i.e., with high foreign exposure, low financial or operating flexibility, or high supply-chain exposure) were shorted more heavily. Moreover, short-selling activities during the COVID-19 pandemic, blamed for triggering stock market crashes, were primarily concentrated around overpriced stocks. This finding supports the argument that short selling plays a prominent role in improving price discoveries. Our research provides timely empirical evidence supporting the U.S. Securities and Exchange Commission's (SEC) non-intervention approach in banning short selling in the U.S. market.