Analysts’ forecast revisions and firms’ research and development expenses

This study examines whether reported values for firms’ research and development (R&D) affect analysts’ annual earnings forecast revisions following quarterly earnings announcements. Because R&D introduces uncertainty into earnings forecasts, analysts may benefit from additional information searches in an effort to increase forecast accuracy. Also, accounting standards mandate an immediate expensing of R&D, in essence projecting a zero value for the R&D. To the extent that R&D will produce future payoffs, the expense treatment reduces the informativeness of reported earnings for forecasting future earnings. Thus, the marginal benefit of analysts’ efforts to produce more information may increase with the magnitude of the R&D component of earnings announcements and trigger additional forecast revisions. Alternatively, if the cost of information searches exceeds the benefit, analysts’ forecast revisions may decrease. Our results show a positive relation between R&D expenses and analysts’ forecast revision activity. We also find a positive and significant association between the level of R&D expenses and the magnitude of analysts’ forecast revisions following quarterly announcements. These results point to a greater amount of analyst scrutiny when reported earnings are accompanied by high levels of R&D expenses. Copyright Springer Science+Business Media, LLC 2007