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R&D Expenditures, Uncertainty and Cost of Capital
Pervaiz Alam, Kent State University
Min Liu, Kent State University
ABSTRACT. In this study, we attempt to demonstrate the association between R&D intensity and the implied cost of capital of U.S. firms. We posit that R&D intensity increases earnings uncertainty thereby giving rise to the possibility of increase in the cost of financing for R&D intensive firms. The results imply that high R&D intensive firms pay more for the cost of financing than low R&D intensive firms or firms with no R&D expenditures on the books. We also present the relationship between R&D intensity and other common risk proxies such as beta and book-to-market ratio, and address the role of capital expenditure and advertising expense in explaining the implied cost of capital. In the evaluation of excess returns for the R&D firms compared with the CRSP value-weight market index, the R&D firm portfolio has statistical and economic significant excess returns. This suggests that the higher returns to larger R&D intensity firms are to compensate for the higher risk.
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