Impact of R&D investments on earnings predictability

The aim of this paper is to empirically investigate the impact of R&D investments on earnings predictability. R&D investments are considered to generate one of the most valuable companies' assets in the era of knowledge economy. This type of investment is however very different from more traditional forms of capital or financial investments. Firstly, R&D projects create more informational asymmetry between a reporting entity and investors. Information about firm's innovation activities is confidential and expected to be hidden from competitors and as a result disclosure level of R&D intensive firms is supposedly low. Secondly, technological and market outcomes of R&D are usually associated with uncertainty and it is very difficult to determine market success of invented products, innovative services and other research accomplishments. On the basis of these two assumptions, we hypothesize that earnings of R&D intensive firms are less predictable. On the sample of more than 900 firms listed on US stock exchange, we examine the relation between firm's R&D intensity and earnings predictability, controlling for firm's profitability, leverage ratio, size and industry affiliation. For measuring the predictability of earnings, we use accounting based metrics proposed by Francis et al. (2006) and Lipe (1990). Earnings predictability is very desirable property of company required by analysts and investors, our findings can have practical implications for estimating cost of capital and valuation of R&D intensive firms.