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.     

The R&D-abnormal return anomaly: a transaction cost explanation

Previous research finds a positive and significant relation between current increases in R&D expenditures and future abnormal stock returns. While the existence of this anomalous pattern is well-established, its underlying causes are the subject of much debate. Recent research also shows that transaction costs can lead to apparent market anomalies such as the post-earnings-announcement drift. We combine these two lines of research and posit that the positive relation between R&D increases and future abnormal stock returns is due to transaction costs. Consistent with this hypothesis, we find that abnormal returns on R&D-based, zero-net-investment portfolios disappear after incorporating standard measures of transaction costs. Overall, our results show that the R&D-abnormal return anomaly is more likely due to transaction costs than to the alternative hypotheses of market inefficiency or omitted risk factors.     

The cost of disclosure regulation: evidence from D&O insurance and nonmeritorious securities litigation

This study examines whether the required disclosure of directors’ and officers’ (D&O) insurance premiums leads to nonmeritorious securities litigation. Our research setting uses a proprietary D&O insurance database that includes New York and non-New York firms, combined with the fact that New York firms must disclose D&O insurance premiums. We thus can exploit a natural experiment based on inter-state variation in disclosure regulation. Disclosed premiums may influence case selection in two ways. First, higher premiums signal higher limits, which plaintiffs’ lawyers likely believe enable higher settlements. Second, higher premiums indicate higher risk assessments from insurers and thus a higher likelihood that stock price drops signal misconduct rather than bad luck. We find that D&O insurance premiums for New York firms are associated with a higher dismissal rate. Offsetting this higher dismissal rate, plaintiffs’ lawyers can achieve higher settlements in the relatively few successful cases.     

Cash holdings and the bargaining power of R&D-intensive targets

Prior literature suggests that R&D-intensive firms hold large amounts of cash due to financing constraints. This paper examines whether such firms could also use cash holdings as a strategic bargaining tool in M&A transactions. Using a large sample of takeover bids announced between 1980 and 2012, we demonstrate that cash holdings positively impact R&D-intensive targets’ takeover premiums and announcement-period abnormal returns. These effects disappear in non-R&D-intensive firms. Controlling for various endogeneity and financing concerns, we also find that R&D-intensive firms build up cash holdings in anticipation of becoming a takeover target. Further analysis indicates that in R&D-intensive firms, such cash holdings are valued highly by the market. Taken together, our findings shed new light on the strategic bargaining role of corporate cash holdings in the outcomes of acquisitions targeting R&D-intensive firms.     

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.     

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.     

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.     

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.     

The effect of globalization and legal environment on voluntary disclosure

We examine how interactions with foreign capital, product, and labor markets affect the disclosure practices of non-U.S. multinational firms. Drawing on literature related to multinationals, country-level legal institutions, and accounting disclosures, we expect that the relation between globalization and voluntary disclosure will be conditioned by the legal environment in a firm's home country. Specifically, while firms from countries with a strong legal environment (e.g., common-law countries) already face pressure for good disclosure, globalization can increase the benefits associated with good disclosure to firms from weak legal environments (e.g., civil-law countries). We use a self-constructed voluntary disclosure index and hand-collected disclosure and foreign activity data for 643 non-U.S. firms from 30 countries for 2003. We find a significant interaction between globalization and the legal environment. This indicates that for the same level of globalization, there is more voluntary disclosure for firms based in weak legal environments. Our results suggest that globalization is an important variable that has been overlooked in much of the previous cross-country research.     

The effect of mandatory CSR disclosure on firm profitability and social externalities: Evidence from China

We examine how mandatory disclosure of corporate social responsibility (CSR) impacts firm performance and social externalities. Our analysis exploits China's 2008 mandate requiring firms to disclose CSR activities, using a difference-in-differences design. Although the mandate does not require firms to spend on CSR, we find that mandatory CSR reporting firms experience a decrease in profitability subsequent to the mandate. In addition, the cities most impacted by the disclosure mandate experience a decrease in their industrial wastewater and SO₂ emission levels. These findings suggest that mandatory CSR disclosure alters firm behavior and generates positive externalities at the expense of shareholders.     

The value relevance of corporate voluntary disclosure in the Middle-East: The case of Jordan

We examine whether higher voluntary disclosure, resulting from privatization and the accompanying governance reforms, enhances the value of privatized Jordanian firms. We use panel data for 243 firm-year annual reports (over a period of 9 years from 1996 to 2004) and employ univariate and multivariate tests in order to test our hypothesis,. We construct a governance index to proxy for the impact of privatized firms’ governance on voluntary disclosure. Also, we control for the endogeneity of voluntary disclosure in its relation with firm value. Our multivariate results indicate that voluntary disclosure is positively associated with firm value. We also find that firm value is associated with industry types as a proxy for size. However, we did not find that growth and liquidity are associated with firm value.     

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。     

A Test of the Debt-Monitoring Hypothesis: The Case of Corporate R&D Expenditures

Studies that test for shareholder wealth effects of announcements of plans to increase R&D expenditures find an average positive effect, but also a significant cross-sectional variation. This study determines whether the effect can be predicted when the announcing firm's capital structure is considered. Results suggest a positive relation between the debt ratio and the R&D induced abnormal stock returns. These results are robust using different industry-adjusted and unadjusted measures of capital structure and while controlling for several potentially influential variables. In addition, the gains to shareholders do not seem to be wealth transfers from bondholders. This evidence provides support to the debt-monitoring hypothesis.     

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.     

The outsourcing of R&D through acquisitions in the pharmaceutical industry

We examine the performance of 160 pharmaceutical acquisitions from 1994 to 2001 and find evidence that on average acquirers realize significant positive returns. These returns are positively correlated with prior acquirer access to information about the research and development activities at target firms and a superior negotiating position. A unique Desperation Index is employed to determine the current status of a firm's internal productivity. We find that firms experiencing declines in internal productivity or which are more desperate are more likely to engage in an outsourcing-type acquisition in an effort to replenish their research pipelines.     

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 rise and rise of IFRS: An examination of IFRS diffusion

We seek to understand the ever-increasing push towards the international harmonization of accounting standards and particularly the inexorable rise of standards produced by the International Accounting Standards Board (IASB). While the primary justifications for the increasing recognition given to these standards (IFRS) are economic, we question whether the empirical evidence to date has yielded convincing support for these arguments. We therefore offer an alternative explanation for the origin and diffusion of IFRS that incorporates social and political factors. Outsourcing the manufacture of accounting standards to a single private agency appears to be a rational, lower cost option – lowering both economic and political costs for individual states as long as they continue to retain residual decision rights with respect to the adoption of IFRS. However, such outsourcing must also be perceived to be legitimate. IFRS confer institutionalized legitimacy because they possess three characteristics required of a technology for global governance. These are sponsorship by powerful interest groups/regulators, internationality and plasticity. We therefore conclude that the widespread diffusion today of IFRS can at best be only partially explained as an economically rational phenomenon. Rather, the demand for legitimate action in the face of tightly coupled and complex global markets is at least equally important in generating support for IFRS.     

R&D Intensity and Corporate Financial Policy: Some International Evidence

This paper presents evidence on the financial policies of firms strongly engaged in research and development activities. By referring to the under-investment paradox, the asset substitution problem, the asset specificity proposition and the information asymmetry literature, we postulate that R&D-intensive firms should adopt specific financial policies. In conformity with our hypotheses, empirical results based on a sample of R&D-intensive and non-R&D firms in four major industrialized countries (Europe, the UK, Japan and the US) show that R&D-intensive firms exhibit significant lower debt and dividend payment levels, but shorter debt maturities and higher cash levels than non-R&D ones.     

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.     

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.