The Stock Market Valuation of Research and Development Expenditures

Louis K.C. Chan, Josef Lakonishok, Theodore Sougiannis

NBER Working Paper No. 7223
Issued in July 1999
NBER Program(s):Asset Pricing

We examine whether stock prices fully reflect the value of firms' intangible assets, focusing on research and development (R&D). Since intangible assets are not reported on financial statements under current U.S. accounting standards and R&D spending is expensed, the valuation problem may be especially challenging. Nonetheless we find that historically the stock returns of firms doing R&D on average matches the returns on firms with no R&D. For companies engaged in R&D, high R&D intensity has a distinctive effect on returns for two groups of stocks. Within the set of growth stocks, R&D-intensive stocks tend to out-perform stocks with little or no R&D. Companies with high R&D relative to equity market value (who tend to have poor past returns) show strong signs of mis-pricing. In both cases the market apparently fails to give sufficient credit for firms' R&D investments. Our exploratory investigation of the effects of advertising on returns yields similar results. We also provide evidence that R&D intensity is positively associated with return volatility, everything else equal. Insofar as the association reflects investors' lack of information about firms' R&D activity, increased accounting disclosure may be beneficial.

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Document Object Identifier (DOI): 10.3386/w7223

Published: Louis K. C. Chan, 2001. "The Stock Market Valuation of Research and Development Expenditures," Journal of Finance, American Finance Association, vol. 56(6), pages 2431-2456, December.

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