Does the Stock Market Underreact to R&D Increases?

Allan C. Eberhart, William F. Maxwell and Akhtar R. Siddique

Volume 4, Number 1, First Quarter 2006

We examine a sample of 8,313 cases, between 1951 and 2001, where firms unexpectedly increase their research and development expenditures (R&D) by a significant amount. We find consistent evidence that our sample firms are undervalued following their R&D increases as manifested in the significantly positive long-term stock returns that our sample firms’ shareholders experience. We also find consistent evidence that our sample firms have significantly positive long-term abnormal operating performance following their R&D increases. Our findings suggest that R&D increases are beneficial investments, and that the market is slow to recognize the extent of this benefit (consistent with investor underreaction).