Research and Development and Firm Risk

Abstract

Spending on R&D has grown faster than other investments. This may result in higher return and higher risk. We focus on the latter and examine how research and development (R&D) affects the risks of US firms. We analyze the impact on the firm’s beta, its systematic and idiosyncratic risk, and the combination of the latter two (total risk). Because investors prefer upside to downside risk, we also analyze whether downside risk is also influenced by R&D. We use panel and quantile regressions and control for dividend payouts, growth, leverage, asset liquidity, firm size, earnings variability, firm age and industry competition. We then show that the impact is positive and highly significant for beta, systematic risk and total risk. The impact on systematic risk contrasts to the finding by McAlister et al. (2007) who find that R&D insulates firms from market downturns and thereby lowers systematic risk. The increases in risks are, moreover, stronger at higher relative levels of R&D spending. Unfortunately for investors, downside risk is also increasing with relative R&D spending. The latter result makes it more difficult for managers to defend R&D investments: while R&D may indeed generate future returns it also adds to the next year’s downside risk of investors.

Keywords: R&D, Beta, Systematic Risk, Idiosyncratic Risk, Total Risk, Downside Risk

JEL Classification: G12, G14, G32