Input Price Shocks and R&D Investment: Evidence from the 1999 Taiwan Earthquake

Abstract

The literature has argued that R&D investment is less susceptible than capital expenditures to short-term cash flow shocks because of high adjustment costs. However, managerial myopia combined with the accounting standard for R&D investment (SFAS No. 2) creates incentives to reduce R&D in response to short-term cash flow shocks. I use the novel setting of the 1999 Taiwan earthquake, which increased production costs for a subset of firms in the US high-technology industry. I find firms hurt by the shock do not decrease capital expenditures but reduce R&D investment, lowering future innovation. As evidence of myopic behavior, I find affected firms are more likely to meet or just beat analyst forecasts. I also find that affected firms are more likely to overstate revenue.

Keywords: Investment, R&D, Earnings Manipulation, Aggressive Revenue Recognition

JEL Classification: G30, G31, G32