Market Underestimation of the Implications of R&D Increases for Future Earnings: The US Evidence

:  This study shows that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. It further shows that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, it documents that in thei...

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Bibliographic Details
Published in:Journal of business finance & accounting 2012-04, Vol.39 (3-4), p.289-314
Main Authors: Ali, Ashiq, Ciftci, Mustafa, Cready, William M.
Format: Article
Language:English
Subjects:
Abnormal returns
analysts' forecasts
Earnings
Earnings announcements
Financial reporting
Forecasts
GAAP
mispricing
R&D
R&D increases
Research & development
Research & development expenditures
Research and development
Stock prices
Stock returns
Studies
U.S.A
underestimation of future earnings
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Summary::  This study shows that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. It further shows that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, it documents that in their forecasts of future earnings, security analysts also underestimate the effect of increase in R&D spending. These results suggest that future abnormal returns following R&D increases are at least in part due to the market's underestimation of the earnings benefits of R&D increases. The finding in this study contributes to the longstanding debate in accounting on whether the US GAAP requirement to expense R&D costs when incurred causes investors to underestimate the benefits of R&D.
ISSN:0306-686X
1468-5957
DOI:10.1111/j.1468-5957.2012.02282.x