Accounting-Based Risk and the Valuation of R&D Intensive Firms

Abstract

We demonstrate that the uncertainty communicated by US R&D accounting is also risk relevant. First, we quantify the information on the uncertainty of future benefits through revisions of expectations regarding future cash flows. R&D significantly influences the market’s revisions of expectations regarding future cash flows (cash flow news) and, slightly, discount rates (discount rate news). This emphasizes that the uncertainty of future R&D-related benefits drives stock return variance. We then examine the risk relevance of this information through its influence on the sensitivities of firm-level cash flow and discount rate news to market return news. Specifically, we gauge whether the stock market beta of R&D active firms is determined by fundamental information or investor sentiment. R&D drives the variation in the sensitivity of firm-level cash flow news to market return news, which supports the view that R&D accounting is risk relevant. There is no pattern on the sensitivity of firm-level discount rate news to market return news, which addresses concerns about the role of R&D-induced sentiment in the stock market beta of R&D active firms.

Keywords: R&D, Risk Relevance, Cash Flows, Variance Decomposition

JEL Classification: G12, G14, M40, M41