The impact of research and development on the fundamentals and market values of firms
In the first essay, we survey the literature on R&D in both economics and finance. We see that in finance, the focus has been on the impact of R&D on market value, but without including any measure of R&D output, such as patent counts or citations, whereas in economics the focus has been on measuring R&D, but without a forward-looking stock portfolio perspective. We propose to expand on both areas, in the following fashion.
In the second essay, we investigate the impact of R&D on the fundamentals of the firm. This in itself is new, since most of the literature focuses on market values and uses firm fundamentals mostly as a way to subdivide the sample into high-growth/low-growth, high-tech/low-tech etc. We explore the relationship between R&D and growth (as represented by sales growth) and profitability (as represented by ROE).
Finally, in the third essay, we explore the impact of R&D activities on market values. The novel factor here relative to the financial literature is the inclusion of measures of R&D output. We include patent counts as a measure of R&D quantity and patent citations as a measure of R&D quality. Relative to the literature in economics, we add the forward-looking, portfolio-based abnormal performance view characteristic to the financial field. Economists use all the measures of R&D that we use, but do so in a snapshot-like, "hedonic" market value equation.
We find that R&D efforts tend to increase the sales growth of companies, but to decrease ROE, consistent with the observation that high-tech companies are typically growth companies (i.e. growth stocks) that forego current earnings for (hopefully much higher) future ones.
When used to form stock portfolios, the R&D spending and citations intensities are effective at discerning winners from losers. The top (bottom) quintile outperforms (underperforms) by about 5% per year both on a cumulative and risk-adjusted basis. Furthermore, in a Fama and French-style regression of returns versus size, B/M and R&D variables, the citations variable is significant, with one additional citation per patent contributing 0.4% to annual cumulative returns.
Research & development--R&D;
Return on equity;