Another R&D anomaly?

Abstract

In this paper, we investigate the relation between stock returns and R&D spending under differentmarket conditions. Our empirical evidence suggests that investors' response to R&D activitiesvaries according to stock market status.Following the conventional definitions of markets, we first categorize the market into fourdifferent states: slightly up (up by 0-20%), bull (up by more than 20%), slightly down (down by 0-20%), and bear (down by more than 20%). Using firms in high-tech industries from 1992 to 2009as our sample, we show that investors value R&D spending consistently positively only when themarket (proxied by the S&P 500) is up. R&D is valued less in the downward market and R&Dresponse coefficients even turn negative during bear markets. However, earnings responsecoefficients are consistently positive regardless of market status. The results remain unchangedafter we control for beta, bankruptcy risk, size, and different measuring windows. Our findingscannot be explained by risk-based hypothesis.The study advances our understanding of the relation between stock returns and R&D activities byempirically documenting its variations in market valuation across different market states;particularly, we found empirical evidence that R&D response coefficients in the down markets arenegative. The study also provides additional input to the ongoing debate on finding the appropriate accounting treatment for intangible assets.