Examining the Impact of Research and Development Expenditures on Tobin's Q

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INTRODUCTION AND LITERATURE REVIEW

As the role and influence of technology impacts firms in the economy and financial markets, so too does the importance of research and development (R&D) spending by corporations. The role of research and development (R&D) on firm productivity and growth are well-documented (Griliches, 1984; 1986) and R&D expenditures across different industries have increased significantly over time (Franzen, Rodgers, & Simin, 2007). As firms and industries continue to evolve, R&D has increasingly become a critical element of firm success and survival (Bremser & Barsky, 2004; Tsai & Wang, 2004).

Table one presents the average R&D intensity (R&D as a percentage of sales) by a large sample of publicly-traded firms drawn from the S&P Compustat Database over the 1976 to 2007 time period. Firms are allocating an increasing portion of their budget outlays to R&D spending. The mean (median) R&D intensity for firms in our sample has grown from 1.75% (0.96%) in 1976 to 7.77% (2.71%) in 2007. Given this increased focus on R&D spending by corporations, it is important to look at the impacts of the spending and how it is perceived by investors.

There is a growing body of research that has studied the influence of R&D on firm behavior as well as the market's reaction to the role of R&D. Chan, Lakonishok, and Sougiannis (2001) found that firms with high R&D to equity market value earned high excess returns. Eberhart, Maxwell, and Siddique, (2004) found that while R&D expenditures were beneficial and firms with high R&D expenditures experienced positive long-term returns, markets were slow to recognize the returns. Chan, Martin, and Kensinger (1990) found increased R&D announcements by high-technology firms resulted in positive abnormal returns on average, whereas announcements by low-technology firms were associated with negative abnormal returns.

Studies by Chan, Martin, and Kensinger (1990) and Szewczyk, Tsetsekos, and Zantout (1996) looked at market response to R&D announcements. Both studies found a positive response to increases in R&D spending. Szewczyk, Tsetsekos, and Zantout (1996) found a positive response to increases in R&D spending, primarily for firms with higher values of Tobin's q (the ratio of the market value of the firm relative to the replacement value). Thus, firms that are perceived to be more productive see a greater response than those that are perceived to be less productive. Hsieh, Mishra, and Gobeli (2003) examined the pharmaceutical industry and found that R&D is a significant factor in improving firm performance across a variety of measures.

Connolly and Hirschey (2005) examined the impact of R&D intensity on Tobin's q and found a positive, linear relationship after controlling for growth, risk, profit margin, and advertising intensity. Huang and Liu (2005) examined R&D intensity in Taiwanese firms and found a curvilinear relationship with respect to R&D spending and profitability. Another interesting approach was that of Gleason and Klock (2006) who attempted to look at R&D as a stock variable instead of a flow variable. They found that the value of R&D expenditures accumulated over the previous five years had a significant, positive impact on Tobin's q. Dutta, Om, and Rajiv (2005) took a different perspective and analyzed a firm's R&D capability instead of intensity. They found that firms with a higher level of capability with respect to R&D tended to have higher levels of Tobin's q.

The consensus of the above research is that R&D intensity is associated with higher levels of firm performance and greater valuation in the financial markets. Our paper contributes to this research in three ways. First, we introduce the curvilinear model to US firms using Tobin's q. Tobin's q is a widely used measure of performance (Lee & Tompkins, 1999). …