R & D and Capital Markets

conomic growth and the consequent welfare improvement of nations and individuals are driven mainly by technological change, as manifested by the however, by antiquated accounting rules and insufficient disclosure by corporations. Despite the obvious benefits of R&D, which generally stretch over extended periods of time, this investment is immediately expensed (written off) in corporate financial reports, leaving no trace of R&D capital on firms' balance sheets and causing material distortions of reported profitability. 2 Immediate expensing is practiced not only for internally generated R&D, but also in the growing number of acquisitions involving large amounts of " R&D-in-process, " further distorting reported performance. 3 The fact that only scant information on R&D and other innovative activities is publicly disclosed by firms compounds the information problems of investors when evaluating high-tech companies. Investors are generally told little about the nature of firms' research activities, such as the share of total R&D devoted to basic research, new product development , or efforts to increase the efficiency of production processes (known as " process R&D "). Nor is information typically furnished about the expected benefits and duration of products under development. Even the total R&D expense reported in corporate income statements often misrepresents the extent of activities aimed at producing innovations , particularly for small companies that do not formally classify such activities as R&D. Given the importance of corporate research activities to capital market practitioners and researchers , and the inadequacy of public information on R&D, I provide in this essay: salient statistics about recent trends in corporate R&D; a brief summary of international disclosure regulations; a survey of the major empirical findings concerning R&D and its benefits, particularly as reflected in capital markets; and some guidelines for investors and analysts engaged in the valuation of R&D-intensive enterprises. Full citations for all studies cited in the text and notes of this paper appear in the References section at the end of the article. 2. The most obvious effect of this accounting practice is to reduce current earnings for companies with high R&D growth. But, as discussed later in this paper, a more subtle distortion is the tendency to inflate popular return-on-investment measures like ROE and ROA. introduction of new products and services, the development of more efficient systems of production , and improvements in the organization and management of commerce and industry. Research and development is the major driver of technological change—hence …