Academic journal article Journal of Sustainable Development

The Impact of Research and Development on the Financial Sustainability of Information Technology (IT) Companies Listed on the S&P 500 Index

Academic journal article Journal of Sustainable Development

The Impact of Research and Development on the Financial Sustainability of Information Technology (IT) Companies Listed on the S&P 500 Index

Article excerpt

Abstract

This paper attempts to determine the impact of research and development (R&D) expenditure on the financial sustainability of the IT industry as represented by the IT companies listed on the S&P 500 index. The impact of R&D expenditure on the intermediate variables of marketing performance, gross margin and technological performance is first ascertained. Further, the impact of each of these intermediate variables on financial sustainability, i.e. the return on assets (ROA), is determined. The empirical result shows that financial sustainability is most strongly affected by gross margins, which in turn are strongly impacted on by R&D (Note 1) intensity. R&D expenditure has a positive impact on sales revenues but a negative impact on technological performance. However, technological performance has a positive impact on financial sustainability. The non-availability of the decomposition of R&D expenditure in the annual reports of these companies poses a limitation to our research. Further, the impact of the time lag between the point at which R&D expenditure is incurred and the point at which it starts to contribute to financial sustainability varies from firm to firm, thereby making it difficult to ascertain the impact of R&D on financial sustainability. However, the results from our study pinpoint a very significant relationship between R&D intensity and gross margins. This also forms the backbone of the pricing strategy formulated by IT companies. Further, there is a very significant relationship between gross margins and financial sustainability, which is measured by ROA (Note 2).

Keywords: marketing, technology, R&D, financial sustainability, return on asset, gross profit, patent

1. Introduction

The impact of research and development expenditure (hereinafter referred to as "R&D expenditure") on financial sustainability has been the subject of research in the past (Artz et al., 2010; Hart & Ahuja, 1996). However, the findings from these studies are mixed. The reasons for these mixed results vary, ranging from differences in the definitions of R&D expenditure (Note 3) and financial sustainability to differences in whether and to what extent the relationship between R&D expenditure and financial sustainability is defined directly or indirectly. Variations in the methodology used for conducting the research may also be a cause of these mixed results.

The definitions of R&D expenditure vary. Research and development expenditure includes current and capital expenditure (private as well as public) on creative work that is conducted systematically to increase knowledge - of humanity, society and cultures - and the use of this knowledge in new applications ("Research and development expenditure," n.d.). R&D covers basic and applied research as well as experimental development. From this definition, it is evident that R&D expenditure is inclusive of current as well as capital expenditure. This poses a challenge to researchers studying the R&D expenditure of any industry as a whole. Generally, one would find a firm's R&D expenditure in its income statement, but due to inconsistencies between various reporting standards, they can also be capitalized in the balance sheet. Therefore, there are incongruities regarding what should be expensed and what should be regarded as an asset. An industry is composed of a number of companies - each of which could present its R&D expenditure differently. The R&D expenditure might be inclusive of current expenditure, capital equipment costs and allowable depreciation expenditure.

Another challenge is the lack of availability of the decomposition of R&D expenditure in companies' annual reports. Not reporting the operating margin results in sufficient detail makes it extremely difficult to relate R&D indices precisely to profitability measures (Scherer, 2001).

Sher and Yang (2005) define R&D intensity as one of the variables affecting firm performance. …

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