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Does the Market Underestimate the Implications of Changes in R&D Investments for Future Earnings?
Ashiq Ali University of Texas at Dallas - School of Management Mustafa Ciftci SUNY at Binghamton William M. Cready University of Texas at Dallas - School of Management December 2007 AAA 2008 Financial Accounting and Reporting Section (FARS) Paper Abstract: Prior studies document a positive association between current changes in the level of R&D investment and one to five year future excess returns. The reason for this positive association is unclear, however. These results may reflect an unidentified R&D or R&D correlated risk factor. Or they may reflect a systematic undervaluation by market participants of future benefits from current changes in R&D investments. Our evidence suggests that investors undervalue the benefits of R&D, and the future excess returns to changes in R&D reflect a correction of this undervaluation. Specifically, we document that investors underestimate the association between changes in R&D investments and future earnings. We also document that future excess returns to changes in R&D investment are concentrated around subsequent earnings announcements.
Keywords: R&D Valuation, Mispricing, Market Efficiency JEL Classifications: G12, G14, G31, M41 Working Paper SeriesDate posted: September 13, 2007 ; Last revised: March 01, 2009Suggested CitationContact Information
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