Effect of R&D investments on persistence of abnormal earnings

Sharad C. Asthana and Yinqi Zhang

Review of Accounting and Finance, 2006, vol. 5, issue 2, 124-139

Abstract: Purpose - This paper sets out to test the effects of firms’ and industry's R&D intensity on persistence of abnormal earnings. Design/methodology/approach - Ohlson's valuation model is used with pooled regressions along with Fama–Macbeth methodology on yearly regressions and partitioning on Herfindahl index to conduct the tests. Findings - It was found that firms’ and industries’ R&D intensities are both positively correlated with persistence of abnormal earnings. The evidence suggests that the positive effect on earnings persistence caused by R&D's effectiveness in mitigating competition dominates the negative effect brought by more risk from R&D projects Practical implications - The fact that the firm's own R&D investment leads to incremental earnings persistence beyond that of the industry suggests the importance of incorporating both industry and firm's R&D intensity in earnings persistence. While industry R&D investment leads to competition mitigation via creation of entry barriers, a firm's own investment in R&D differentiates its products from those of its competitors, and thereby results in further competition mitigation by creating replacement barriers. Originality/value - Finally, since R&D intensity is correlated with earnings persistence, inclusion of R&D intensity in future earnings persistence studies may lead to better model specification by reducing the problem of correlated omitted variables.

Keywords: Research and development; Project management; Competitors (search for similar items in EconPapers)
Date: 2006
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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:14757700610668967

DOI: 10.1108/14757700610668967

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