R&D and Stock Returns: Is There a Spill-Over Effect?

We examine the externality effects of R&D investments. We find that firms’ future operating performance is positively related to industry peers’ (all peer firms, or R&D leaders in the industry) R&D expenditures. Firms also tend to experience positive abnormal returns following industry peers’ high R&D expenditures. This suggests that the market not only under react to a firm’s own R&D investments (as suggested by both previous and our studies), but also to industry peers’ R&D investments. Consistent with this notion, the market is surprised by firms’ earnings performance following high peer R&D investments. Finally, we present evidence that the positive externalities of R&D investments may be due to the market expansion caused by technology advances.