Market Underestimation of the Implications of R&D Increases for Future Earnings: The US Evidence

26 Pages Posted: 21 Apr 2012  

Ashiq Ali

University of Texas at Dallas - Naveen Jindal School of Management

Mustafa Ciftci

American University of Sharjah - School of Business and Management

William M. Cready

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: April/May 2012

Abstract

This study shows that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. It further shows that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, it documents that in their forecasts of future earnings, security analysts also underestimate the effect of increase in R&D spending. These results suggest that future abnormal returns following R&D increases are at least in part due to the market's underestimation of the earnings benefits of R&D increases. The finding in this study contributes to the longstanding debate in accounting on whether the US GAAP requirement to expense R&D costs when incurred causes investors to underestimate the benefits of R&D.

Keywords: R&D increases, mispricing, underestimation of future earnings, analysts’ forecasts

Suggested Citation

Ali, Ashiq and Ciftci, Mustafa and Cready, William M., Market Underestimation of the Implications of R&D Increases for Future Earnings: The US Evidence (April/May 2012). Journal of Business Finance & Accounting, Vol. 39, Issue 3‐4, pp. 289-314, 2012. Available at SSRN: https://ssrn.com/abstract=2042956 or http://dx.doi.org/10.1111/j.1468-5957.2012.02282.x

Ashiq Ali (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 West Campbell Road, SM41
Richardson, TX 75080-3021
United States
972-883-6360 (Phone)
972-883-6811 (Fax)

HOME PAGE: http://www.utdallas.edu/~axa042200/

Mustafa Ciftci

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

P.O. Box 26666
Sharjah
United Arab Emirates

William M. Cready

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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