FINANCE Corporate financial policy and R and D Management

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Innovation, R&D, and Stockholder Wealth


It is well known that there is substantial underinvestment in R&D in the
United States economy, primarily because social benefits exceed private
rates of return from innovative activities (Mansfield, Rappaport, Romeo,
Wagner, and Beardsley 1977). Furthermore, underinvestment in R&D di-
minishes potential stockholder wealth because R&D activities have been
associated with the market value of major industrial firms (Ben-Zion 1984;
Guerard, Bean, and Stone 1990; and Guerard and Mark (2003). It is help-
ful to model the R&D budgetary process of major industrial companies,
since empirical evidence supports the hypothesis that decisions on R&D
expenditures are made simultaneously with a firm’s other financial deci-
sions (Switzer 1984; Guerard and McCabe 1992), as discussed in Chapter



  1. A firm’s decision to increase its R&D expenditures impacts its decisions
    on dividends, investments, and new debt issuance. Thus, there is a need to
    understand how corporate decisions on expenditure reallocation may af-
    fect a firm’s stock price.
    As discussed earlier, in Chapter 6, the empirical research on the per-
    fect markets hypothesis has yielded mixed results since its formulation
    by Miller and Modigliani (1961), although the majority of studies pub-
    lished in the 1970s support the existence of imperfect markets. A review
    of this research led Guerard, Bean, and Stone (1990) to formulate a re-
    vised model of the stock price valuation process that allows interdepen-
    dencies that were precluded by the perfect markets hypothesis. One of
    the goals of this study was to revive the Mueller (1967) hypothesis that
    research and development expenditures should be included in tests of
    the perfect markets hypothesis. Guerard, Bean, and Stone (1990) used
    data obtained from Compustat and U.S. Patent Office tapes to estimate
    such a model.
    In July 1984, the National Science Foundation and the U.S. Bureau
    of the Census announced the availability of a longitudinal database
    that would enable researchers to explore the relationship between R&D
    and other economic variables on an enterprise basis. This chapter com-
    pares the results obtained from the NSF data with those derived from
    the Compustat/Patent Office data. The model used in the Guerard and
    McCabe (1992) study assumes interdependence between several finan-
    cial decisions. It employs investment, dividends, and new capital financ-
    ing equations to describe the firm’s budget constraint. The manager
    may use available funds for research and development (R&D), capital
    investment (CE), or dividends (DIV), or to increase net working capi-
    tal (LIQ). The sources of funds are represented by net income (NI), de-


182 COMPARING CENSUS/NSF R&D DATA WITH COMPUSTAT R&D DATA
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