Is R&D Mispriced or Properly Risk-Adjusted?

40 Pages Posted: 3 May 2006 Last revised: 29 Sep 2008

See all articles by Mustafa Ciftci

Mustafa Ciftci

American University of Sharjah - School of Business and Management

Baruch Lev

New York University - Stern School of Business

Suresh Radhakrishnan

JSOM, University of Texas at Dallas

Date Written: August 31, 2008

Abstract

Research has established that R&D-intensive firms are characterized by substantial future risk-adjusted stock returns. The reasons for this phenomenon and its policy implications, however, are widely debated. Some attribute the excess returns to investors' systematic undervaluation of R&D firms and argue for improved disclosure to mitigate the mispricing, while others claim that the excess returns are just compensating for an R&D-specific risk factor and, therefore, no accounting changes are called for.

We aim at resolving this controversy by distinguishing between "R&D leaders" who focus mainly on basic research, and their activities are obscured from investors and therefore susceptible to mispricing, and "R&D followers" who largely modify current technologies and are therefore more transparent. We show that R&D leaders enjoy substantial risk-adjusted returns during the first four-five future years, after which these excess returns converge to those of R&D followers. This evidence is consistent with a significant undervaluation of the shares of R&D leaders. We also show that both R&D leaders and followers enjoy long-term excess returns which are attributable to both business and information risks. Regarding policy implications, we show that the excess returns of R&D leaders (reflecting undervaluation) are cut in half by voluntary information disclosure (earnings guidance). Improved information is an obvious remedy for share mispricings.

Keywords: R&D Valuation, Innovation Strategy, R&D mispricing, R&D risk

Suggested Citation

Ciftci, Mustafa and Lev, Baruch Itamar and Radhakrishnan, Suresh, Is R&D Mispriced or Properly Risk-Adjusted? (August 31, 2008). Available at SSRN: https://ssrn.com/abstract=898693 or http://dx.doi.org/10.2139/ssrn.898693

Mustafa Ciftci

American University of Sharjah - School of Business and Management ( email )

P.O. Box 26666
Sharjah
United Arab Emirates

Baruch Itamar Lev

New York University - Stern School of Business ( email )

40 West 4th Street, Suite 400
New York, NY 10012
United States
212-998-0028 (Phone)
212-995-4001 (Fax)

HOME PAGE: http://www.baruch-lev.com

Suresh Radhakrishnan (Contact Author)

JSOM, University of Texas at Dallas ( email )

Mail Stop SM 41
800 West Campbell Road
Richardson, TX 75080
United States
972-883-4438 (Phone)
972-883-6811 (Fax)

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