Excess Returns to R&D-Intensive Firms

Recent studies indicate that both current Ramp;D investment levels and current or recent changes in Ramp;D investment are positively associated with subsequent excess (risk-adjusted) stock returns. The tentative explanation offered for these results is that shares of Ramp;D-intensive firms are quot;mispricedquot; because investors fail to see through earnings distortions caused by conservative accounting for Ramp;D costs. However, an alternative explanation is that conventional controls for risk do not completely capture the riskiness of Ramp;D-intensive firms, causing measured excess returns for these firms to be biased upward. This study provides evidence useful for distinguishing between the mispricing and risk explanations for Ramp;D-related excess returns. Overall, our empirical results suggest that the positive association between Ramp;D investment levels and excess returns is more likely to result from failure to control adequately for risk than from mispricing. On the other hand, our results do not rule out the possibility of a second source of excess returns that are due to mispricing and that are associated with changes in the level of Ramp;D investment