106th Seminar on Finance and Accounting

Topic: The Market Valuation of R&D Decreases

 

Presenter:Konan Chan, Associate Professor, School of Economics and Finance, University of Hong Kong 

 

Time: May 22, 2009(Friday)3:00—4:30PM

 

Venue: Room 501, Jiageng Bld 2

 

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Abstract:

 

While many studies document that R&D investments significantly contribute to firm value, there

is very little existing research which investigates whether the reduction in R&D expenditures

creates any negative impact on firms’ performance. This paper examines long-term performance

following significant R&D decrease. We find that firms with large decline in R&D generate a

significantly positive abnormal stock return in the long-run. This return drift cannot be explained

by previously documented determinants of cross-section returns, such as size, book-to-market

ratio, momentum, accruals, asset growth and net share issuance. We explore three economic

motives behind R&D decrease – R&D spillover, managerial myopia and overinvestment – to

account for the associated abnormal returns. We find no compelling evidence to support either the

spillover or myopia explanation. Our results are most consistent with the overinvestment

hypothesis that firms cut down R&D investments to mitigate the agency problem. Firms with low

growth opportunities generate higher future returns than their R&D decrease counterparts. Also,

firms decrease their cost of capital after R&D decrease and these firms with declining cost of

capital outperform. Our results suggest that the market underestimates the decline in cost of

capital following R&D reduction.

 

 

Presenter Introduction: 

  • Konan Chan received his Ph.D. from the University of Illinois at Urbana-Champaign, after which he taught at the Case Western Reserve University and National Taiwan University. He joined the School of Economics and Finance/School of Business in August 2005. His research interests include Corporate finance, Repurchases, Equity offerings, M&A and Asset pricing.