The Impact of Intangible Investment on the Relative Importance of Firm-Specific Factors versus Market- and Industry-Level Factors in the Determination of Firm-Level Earnings

We examine the effect of intangible investment on earnings non-commonality, defined as the extent to which a firm’s earnings performance is determined by firm-specific factors versus marketand industry-wide factors. Such insight is important in determining the appropriate weight to place on each of these factors when forecasting a firm's earnings. We measure earnings non-commonality as the unexplained portion (i.e., 1 minus the R) from firm-specific regressions of quarterly return on assets (ROA) on marketand industry-level ROA indices. Higher levels of our non-commonality measure are consistent with firm-level earnings that are more dependent on firm-specific factors as opposed to market and industry factors. For a sample of U.S. firms over the 1980 to 2006 period, we find that earnings non-commonality is positively associated with a firm’s intangible asset intensity. This finding is consistent with the resource-based view (RBV) of the firm, which posits that intangible investments allow firms to differentiate themselves economically from their rivals. We also find that separable recognized intangible assets contribute more to earnings non-commonality than either goodwill or R&D investments, perhaps because separable recognized intangibles are more likely to arise from contractual or legal rights and, therefore, may be less susceptible to expropriation by rival firms, which might lead to commonalities in firms’ earnings performance. Finally, we find that the positive impact of R&D investment on earnings non-commonality is significantly greater for those industries where patents and other legal mechanisms are most effective in protecting R&D. This result suggests that the success of intangible investment as part of a differentiation strategy depends largely on the effectiveness of mechanisms used to protect intangible investments from expropriation.