The Relation between R&D, Earnings Growth, Operating Leverage, and Stock Returns

• In Event: DSFI: Part I

Abstract

I propose and test a risk-based explanation for the positive relation between R&D, future earnings, and future stock returns based on the intersection of operational restructuring and operating leverage. The average high R&D firm has recently realized a negative demand shock, pushing down growth expectations. In response high R&D firms restructure, however, because R&D is a fixed cost, drops in R&D are slower than drops in tangible asset investment and sales leading to higher operating leverage. The restructuring of cost and capital structures explains the profit and investment patterns linked to R&D firms while the fixed-cost qualities of R&D seem to explain future stock returns. The collective empirical evidence strongly supports this alternative explanation while challenging explanations offered in prior studies.

Author

• Robert J Resutek, University of Georgia