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R&D expenditures and implied equity risk premiums

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  • Pervaiz Alam
  • Min Liu
  • Xiaofeng Peng

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

Suggested Citation

  • Pervaiz Alam & Min Liu & Xiaofeng Peng, 2014. "R&D expenditures and implied equity risk premiums," Review of Quantitative Finance and Accounting, Springer, vol. 43(3), pages 441-462, October.
    • Handle: RePEc:kap:rqfnac:v:43:y:2014:i:3:p:441-462
    DOI: 10.1007/s11156-013-0381-9
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    Cited by:

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    2. Ahmed, Mohamed S. & Alhadab, Mohammad, 2020. "Momentum, asymmetric volatility and idiosyncratic risk-momentum relation: Does technology-sector matter?," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 355-371.
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    4. Petr Bora & Michal Vaněk, 2017. "Estimating the Cost of Equity Using a Mining Build-up Model," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 65(5), pages 1643-1653.
    5. Patrick Bielstein & Matthias X. Hanauer, 2019. "Mean-variance optimization using forward-looking return estimates," Review of Quantitative Finance and Accounting, Springer, vol. 52(3), pages 815-840, April.

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    More about this item

    Keywords

    R&D; Risk premium; Cost of capital; Portfolio choice; Market adjusted return; Abnormal return; G11; M40; M41; O30;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General

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