R&D Information Quality and Stock Returns

Abstract

Investors demand higher premiums from firms whose future performance in R&D is difficult to evaluate. We construct a measure that captures investors' evaluation of a firm's R&D information quality (RDIQ) by linking a firm's historical innovation input (R&D expenditures) and innovation outcome (sales) and find significant evidence that expected excess returns decrease with RDIQ. The high-minus-low RDIQ hedge portfolio earns excess returns of about -23 (-25) basis points per month in value-weighted (equal-weighted) returns. The RDIQ effect is weakly correlated with commonly used risk factors, is stronger for firms with greater uncertain business environment, and exhibits incremental pricing power.

Keywords: Research and Development; Innovation; Information Quality; Return Predictability; Factor Models.

JEL Classification: G12, G14, O32