On the Trade-Off between the Future Benefits and Riskiness of R&D: A Bondholders' Perspective

Abstract

Existing studies on the value-relevance of R&D tend to overstate the R&D benefits and shed little light on the trade-off between the R&D benefits (mean effect) and their riskiness (variance effect). This study shows that the variance effect of R&D is on average more significant than their mean effect in bond valuation. Hence, for creditors, the R&D risk dominates their benefits. Furthermore, this study documents that R&D measures alone explain approximately 80 percent of cross-sectional variations in bond ratings and risk premium. These findings contribute to the debate over R&D accounting and the bond pricing literature.

Keywords: benefits of R&D, riskiness of R&D, option pricing theory, bond pricing

JEL Classification: C30, G10, G12, G32, M41