The Changing Implications of Research and Development Expenditures for Future Profitability

Abstract

We document strong evidence of a declining relation between R&D and future profitability, which coincides with a number of important economic changes including a significant increase in R&D spending. We identify several contributors to this decline, including changes in the nature and riskiness of R&D projects and a shift in the types of firms undertaking R&D in our sample (e.g., successive cohorts, STEM versus non-STEM firms). We also demonstrate variation in the implications of R&D for future profitability consistent with diminishing marginal returns to R&D investments. Overall, our evidence suggests that in earlier time periods, investments in R&D offered high returns in U.S. public firms, but that in more recent times these returns have stabilized at lower levels. Our study offers important insights for financial statement users, managers, and researchers.

Keywords: R&D; Earnings Implications; Capital Markets; Analysts; Investors

JEL Classification: M41, M45