Measuring Distress Risk: The Effect of R&D Intensity

59 Pages Posted: 3 Dec 2005 Last revised: 23 Mar 2014

See all articles by Laurel Franzen

Laurel Franzen

Loyola Marymount University

Kimberly Cornaggia

Pennsylvania State University - Department of Finance

Timothy T. Simin

Pennsylvania State University

Date Written: July 20, 2006

Abstract

Because of upward trends in research and development activity, accounting measures of financial distress have become less accurate. We document that (1) higher research and development spending increases the likelihood of misclassifying solvent firms, (2) adjusting for conservative accounting of research and development increases the number of correctly identified distressed firms, and (3) adjusted measures of distress alleviate previously documented anomalously low returns of large high distress risk, low book-to-market firms. The results hold after updating stale parameters and under various tax assumptions. Our evidence raises concerns about interpretation of extant literature that relies on accounting measures of distress.

Keywords: Accounting conservatism, bankruptcy prediction, distress risk, financial distress

JEL Classification: G33, M41, M44

Suggested Citation

Franzen, Laurel and Cornaggia, Kimberly and Simin, Timothy T., Measuring Distress Risk: The Effect of R&D Intensity (July 20, 2006). AFA 2007 Chicago Meetings Paper, Journal of Finance, Vol. 62, No. 6, pp. 2331-2368., Available at SSRN: https://ssrn.com/abstract=861226

Laurel Franzen

Loyola Marymount University ( email )

7900 Loyola Boulevard
Los Angeles, CA 90045
United States

Kimberly Cornaggia

Pennsylvania State University - Department of Finance ( email )

306 Business Bldg
University Park, PA 16802
United States
814-865-2243 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://directory.smeal.psu.edu/kjr15

Timothy T. Simin (Contact Author)

Pennsylvania State University ( email )

University Park, PA 16802
United States
814-865-3457 (Phone)

HOME PAGE: http://timsimin.net

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