R&D Increases and Long‐Term Performance of Rivals

AuthorSheng‐Syan Chen,Weifeng Hung,Yanzhi Wang
Published date01 November 2014
Date01 November 2014
The Financial Review 49 (2014) 765–792
R&D Increases and Long-Term
Performance of Rivals
Sheng-Syan Chen
National Taiwan University
Weifeng Hung
Feng Chia University
Yanzhi Wang
National Taiwan University
We examine how a firm’s research and development (R&D) increases affect its intra-
industry competitors in the long run. Consistent with the R&D spillover hypothesis, when a
firm unexpectedly increases its R&D spending, its intra-industry competitors experience im-
provements in operating performance and analyst forecast revisionsand earn positive abnormal
stock returns in the long run. The industry concentration, which is related to the firm’sstrategic
reaction, is crucial in determining the magnitude of the R&D spillover effect.
Keywords: R&D, spillover, intra-industry
JEL Classifications: G30, G31
Corresponding author: Department of Finance, Feng Chia University,No. 100 Wenhwa Road, Seatwen,
Taichung, Taiwan 40724, R.O.C.; Phone: 886-4-24517250, ext. 4173; Fax: 886-4-2451-3796; E-mail:
This research is supported by a grant from the Taiwan National Science Council (NSC 99-2410-H-
C2014 The Eastern Finance Association 765
766 S.-S. Chen et al./The Financial Review 49 (2014) 765–792
1. Introduction
Research and development (R&D) spending has attracted increasing attention
in the academic literature, and it is no longer considered an expense but is instead
seen as a value-enhancing investment. For example, many studies show that R&D
investment is a favorable strategy for the investing firm. When a firm increases its
R&D outlay,it earns positive abnormal returns both in the short run (Chan, Martin and
Kensinger, 1990; Szewczyk, Tsetsekos and Zantout, 1996) and in the long run (Lev
and Sougiannis, 1996; Chan, Lakonishok and Sougiannis, 2001; Eberhart, Maxwell
and Siddique, 2004, 2008; Hsu, 2009; Li, 2011; Chen, Yu, Su and Lai, 2012).
We explore the impact of R&D investment on rival firms. On one hand, the
economic literature suggests the existence of an R&D spillover effect (Levin and
Reiss, 1984; Jaffe, 1986; Bernstein and Nadiri, 1989). The R&D spillover effect
indicates that an increase in R&D expenditure at a given firm positivelyaffects other
companies in the same industry.1In this sense the R&D effecton rivals is positive. On
the other hand, Zantout and Tsetsekos (1994) find that the rivals of firms that make
announcements of increases in R&D expenditures suffer statistically and significantly
negative abnormal returns. Sundaram, John and John (1996) also find that the short-
run market reaction to competitors varies depending on their competitive strategy
Lev and Sougiannis (1996) and Chan, Lakonishok and Sougiannis (2001) sug-
gest that R&D investment is difficult to realize and to be correctly evaluated over
the short run. Moreover, managers seldom announce R&D increases formally. As a
result, the market might take time to fully reflect managers’ investment decisions.
Thus, a long-term approach is more appropriate in capturing the intangible features
of R&D investment.
If the market underreacts to the direct future benefits of the R&D increases,
which is explored by Eberhart, Maxwell and Siddique (2004), then it might also
underreact to indirect future benefits, or the R&D spillover effect, which a firm’s
rivals may obtain from the firm’s R&D increase. R&D increases provide a natural
experiment in examining the long-run market reaction to the R&D spillover effect, a
form of indirect intangible information. As a result, we expect to see the long-term
abnormal returns of rivals are positive, if rivals do benefit from the knowledge inflow
from the spillover effect.
1Researchers explore the intra-industry effect of many types of corporate events. See Brander and Lewis
(1986) for leverage; Lang and Stulz (1992) and Brewerand Jackson (2000) for bank failures; Firth (1996),
Howe and Shen (1998) and Laux, Starks and Yoon(1998) for dividend changes; Ecbko (1983) and Servaes
and Tamayo (2004) for mergers;and Erwin and Miller (1998) and Massa, Rehman and Vermaelen (2007)
for share repurchase announcements.
2Competitive strategy measure is the impact of a firm’s profitson changes in its competitors’ revenues.
The sign of measure depends on competition style: strategic substitute or complement.

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