R&D Spending and Stock Returns: Evidence from South Korea

Abstract

This study examined how research and development (R&D) spending affects stock returns. Three strands of research make different predictions about how R&D affects stock prices. The agency theory, presented by Jensen (1986) argues that managers do not make a corporate decision on behalf of shareholders and rather pursue their personal benefits by undertaking value-reducing projects such as R&Ds. The overconfidence theory suggests that overconfident managers tend to invest more in R&D because they overvalue their ability and they are excessively optimistic about future success of the R&D investment. These two theories predict that firms that invest more in R&D earn lower returns than those that invest less. In contrast, the signaling theory predicts that high-quality firms use R&D spending as a means of communicating with the stock market to mitigate information asymmetry problem, resulting in higher returns of the firms. Using data from Korean firms listed from January 1992 to December 2015 we showed that portfolios that invested heavily in R&D earn consistently high abnormal returns and that, consequently, spending on R&D is an effective explanatory factor for stock returns. We also found that the impact R&D expenditures has on stock value was long-term, as well as short-term. Overall, these results are consistent with the signaling theory in that R&D spending is an important channel through which firms improve their values by communicating with the stock market.