Working Paper: NBER ID: w7223
Authors: Louis K.C. Chan; Josef Lakonishok; Theodore Sougiannis
Abstract: We examine whether stock prices fully reflect the value of firms' intangible assets, focusing on research and development (R&D). Since intangible assets are not reported on financial statements under current U.S. accounting standards and R&D spending is expensed, the valuation problem may be especially challenging. Nonetheless we find that historically the stock returns of firms doing R&D on average matches the returns on firms with no R&D. For companies engaged in R&D, high R&D intensity has a distinctive effect on returns for two groups of stocks. Within the set of growth stocks, R&D-intensive stocks tend to out-perform stocks with little or no R&D. Companies with high R&D relative to equity market value (who tend to have poor past returns) show strong signs of mis-pricing. In both cases the market apparently fails to give sufficient credit for firms' R&D investments. Our exploratory investigation of the effects of advertising on returns yields similar results. We also provide evidence that R&D intensity is positively associated with return volatility, everything else equal. Insofar as the association reflects investors' lack of information about firms' R&D activity, increased accounting disclosure may be beneficial.
Keywords: Research and Development; Stock Market Valuation; Intangible Assets
JEL Codes: G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| R&D expenditures (O32) | stock market performance (G10) |
| R&D intensity (O32) | return volatility (G17) |
| high R&D relative to equity market value (O32) | mispricing (D49) |
| R&D-intensive stocks (O32) | outperform stocks with little or no R&D (O32) |
| market underestimates future opportunities associated with high R&D spending (G17) | mispricing (D49) |
| investors' excessive optimism about potential technological breakthroughs (D84) | mispricing (D49) |