The Stock Market Valuation of R&D Leaders

Abstract

We examine future excess returns, earnings variability and stock volatility of R&D Leaders and Followers. Drawing on the business strategy literature, which makes a clear distinction between R&D Leaders and Followers, we show that R&D Leaders do earn significant future excess returns, while R&D Followers just earn average returns. We further document that R&D Leaders generate higher future sales growth, and return-on-assets than Followers. We also tackle the perennial question of whether the excess returns subsequent to R&D are due to mispricing or risk, and show that only a small part of the returns can be attributed to risk compensation. Finally, it has been documented that R&D expenditures are strongly associated with future earnings volatility, suggesting that R&D is less reliable (verifiable) an asset than physical capital. We show that the association between R&D intensity and future earnings volatility of R&D Leaders is not lower than that of R&D Followers. Thus, penetrating the population of R&D firms to distinguish between R&D Leaders and Followers, we bridge the chasm between the major findings of the economics/finance strand and the accounting body of R&D research.