The Changing Implications of Research and Development Expenditures for Future Profitability

• In Event: Determinants of Future Earnings Performance

Abstract

We examine the implications of the significant increase in aggregate R&D investment over time for estimates of R&D profitability. We estimate that the profitability of R&D has declined by 70 percent (on average) and 35 percent (within firm) between the early and later parts of our sample period. Neither analysts nor investors appear to correctly understand the changing nature of R&D expenditures, leading to predictable long-term growth forecast errors and medium-term reversals in stock prices in recent periods. We provide evidence on the robustness and pervasiveness of the decline in profitability as well as preliminary evidence on the role of competition and investment risk in explaining the lower profitability of R&D. Our results inform market participants and researchers assessing the implications of R&D for future earnings.

Authors

• Asher Curtis, University of Washington

• Sarah E McVay, University of Washington

• Sara Toynbee, University of Washington