The Effect of Research and Development (R&D) Inputs and Outputs on the Relation between the Uncertainty of Future Operating Performance and R&D Expenditures

Abstract

Consistent with the uncertainty of research and development’s future benefits, prior accounting studies hypothesize and find a positive relation between research and development (R&D) and the variability of future earnings. However, prior research has assumed constant marginal productivity of R&D in the cross section. We relax this assumption and advance the accounting literature on the informational role of R&D by studying how measures of innovation outputs, namely patent counts and patent citations, which proxy for the economic value of innovation, are related to firms’ future performance. We predict and find that firms’ future operating performance is positively related to the quality of their patents and that this relation is stronger for more productive and innovative firms. We also predict and find that the volatility of future operating performance is negatively related to patent quality and that the relation is stronger for firms with higher R&D expenditures and larger patent portfolios. Overall, firms that have R&D that is more productive exhibit higher and less volatile future operating performance. One contribution of our study is that it demonstrates that the relation between R&D expense (i.e., inputs) and future operating performance is better understood by incorporating information about the productivity’ (i.e., outputs) of a firm’s R&D outlays in the form of patent counts and citations.

Patent Citations and Financial Analysts’ Long-Term Growth Forecasts

“…In line with this, prior studies have reported a significant positive association between patent citations, Tobin's Q, and future earnings [7,8,28,31]. A large number of citations by other firms suggests corporate sustainable growth opportunities in the field, as well as the ability of an innovation to overcome uncertainty regarding economic outcomes.…”

“…Existing studies have shown that a firm's patents with high citations are positively related to its market value [5,31] and/or future financial performance [7,8]. Based on this empirical evidence, our study examines whether this positive effect of impactful patents on firm performance is considered by financial analysts in their forecasting activities.…”

“…One vital component of these indicators is patent citation information. Since patents with strong potential future impacts are more likely to be cited than less important ones, prior studies report that patent citations are good proxies for firm innovativeness [3][4][5][6], and are associated with positive future firm performance [7,8]. Thus, the number of patent citations is, in general, considered a reliable indicator for technological leadership and sustainable future performance.…”

The Impact of Research and Development on the Financial Sustainability of Information Technology (IT) Companies Listed on the S&P 500 Index

“…Hunton et al (2003) observe that ROA (Return on Assets), ROS (Return on Sales) and ATO (Asset Turnover) is significantly lower for non-ERP (Enterprise Resource Planning) adopters than for ERP adopters in the third year after ERP implementation. Pandit et al (2011) measure firm performance in terms of net income and operating cash flows. They find that the mean level of future operating performance is positively associated with the quality of a firm's patents.…”

Can locally-recruited R&D personnel significantly contribute to multinational subsidiary innovation in an emerging economy?

“…Specifically, we focus on R&D activities which can be measured in terms of R&D input and output. R&D input is R&D expenditure, and R&D output is patent counts and citations (Pandit, Wasley & Zach, 2011). Using these definitions, this paper develops two hypotheses based on a network approach to multinational enterprises in an emerging economy setting and tests them on a panel data set from 317 multinational subsidiaries in China over the period [1999][2000][2001][2002][2003][2004][2005].…”