The Effects of R&D Expenditures on Bondholders

Abstract

Purpose – The relation between research and development (R&D) expenditures and bondholder wealth is examined. Methodology/approach – A sample of firms that increase R&D expenditures is partitioned into two subsamples: firms with high default risk versus firms with low default risk. For each subsample, we examine the effect of R&D increases on bond returns and default risks. Findings – For firms with high default risk, R&D increases have a negative impact on bond returns and default risk. Further, there is a wealth transfer from bondholders to stockholders surrounding R&D increases. Neither of these results is found for firms with low default risk. Research limitations/implications – The present study highlights the importance of assessing firm's existing default risk to understand the effects that R&D expenditures have on bondholders. Social implications – The study reveals a potential social welfare and economic cost, as it reveals that stockholders may be able to gain wealth at the expense of bondholders. Originality/value – The study provides important insights to bondholders on how firms’ investment policies, such as R&D expenditures, may affect their wealth.