The Effect of R&D Investment on Future Earnings Uncertainty: New Evidence

Abstract

The effect of R&D on firms’ future earnings uncertainty is an important factor in the decision of accounting treatment of the investment (expensing vs. capitalization). This study provides new evidence on the effect of R&D investment on future earnings uncertainty. We posit that R&D investment and future earnings uncertainty are simultaneously associated. On the one hand, high earnings uncertainty increases firms’ incentive to invest in R&D because R&D strengthens firms’ innovative capability and competitiveness in an uncertain environment. On the other hand, the outcome of R&D project is subject to uncertainty, but the advantage of R&D can also lead to durable and persistent future benefits, rendering the effect of R&D on future earnings variability an empirical question. Our examination of the simultaneous relation between R&D investment and future earnings uncertainty indicates that like capital expenditure, R&D does not increase the variability of future earnings. We also find that for firms with relatively high R&D investment intensity, R&D has a stronger effect on decreasing firms’ future earnings variability than capital expenditure. This result is in contrast to earlier evidence that R&D and capital investment increase future earnings uncertainty and that R&D has greater association with future earnings uncertainty than capital investment.