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Effect of R&D investments on persistence of abnormal earnings

Effect of R&D investments on persistence of abnormal earnings 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting and Finance Emerald Publishing

Effect of R&D investments on persistence of abnormal earnings

Review of Accounting and Finance , Volume 5 (2): 16 – Apr 1, 2006

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Publisher
Emerald Publishing
Copyright
Copyright © 2006 Emerald Group Publishing Limited. All rights reserved.
ISSN
1475-7702
DOI
10.1108/14757700610668967
Publisher site
See Article on Publisher Site

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.

Journal

Review of Accounting and FinanceEmerald Publishing

Published: Apr 1, 2006

Keywords: Research and development; Project management; Competitors

References

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