R&D expenditures and implied equity risk premiums

Pervaiz Alam, Min Liu and Xiaofeng Peng ()

Review of Quantitative Finance and Accounting, 2014, vol. 43, issue 3, 462 pages

Abstract: This study investigates the relationship between research and development (R&D) expenditures and risk premiums implied in the costs of equity capital. We posit that R&D expenditures represent an information risk factor resulting from both information asymmetry about R&D between investors and managers and low-quality R&D reporting that impairs the coordination between investors and managers with respect to managers’ investment decisions. Our results support our position by showing a positive association between R&D expenditures and implied equity risk premiums. From this research along with prior studies, investors can have better knowledge about the risky nature of R&D expenditures that drive up implied risk premiums and at the same time provide opportunities to earn excess returns in a short to long horizon. Accounting standard setters can benefit from this study’s findings that R&D expenditures represent an off-balance-sheet risk factor and thus warrant reconsidering SFAS No. 2 for potential capitalization of R&D expenditures. Copyright Springer Science+Business Media New York 2014

Keywords: R&D; Risk premium; Cost of capital; Portfolio choice; Market adjusted return; Abnormal return; G11; M40; M41; O30 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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DOI: 10.1007/s11156-013-0381-9

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