Abstract This paper investigates whether current R&D investment levels and its changes in R&D investment are positively associated with the subsequent excess stock returns and the reasons there of. The tentative explanation offered for these results is that shares of R&D-intensive firms are “mispriced” because investors fail to see through earnings distortions caused by conservative accounting for R&D costs. However, an alternative explanation is that conventional controls for risk do not completely capture the riskiness of R&D intensive firms, causing excess returns for these firms to be upward.
The study applies the cost basis framework, used by Chan et al.(2001) and Chambers et al.(2002) to estimate the proportion of R&D cost of the firm that represents the investment in R&D asset. Overall, empirical results suggest that the positive association between R&D investment levels and excess returns is more likely to result from the failure to control and compensate for risk rather than from mispricing.
This paper also investigates how different firm-specific characteristics like R&D intensity, profitability, sales growth, size and risk are associated with the ratio of R&D asset to the firm’s excess returns, i.e. the R&D capital ratio. The results indicate that the R&D capital ratio can be explained by different firm-specific characteristics such as R&D intensity, profitability and size in Korea.
