The Effect of the Amount of Research and Development Spending on the Growth and Profitability of a Firm: An Empirical Study on US-based Publicly Traded Companies

Abstract

This thesis studies how the amount of research and development (R&D) spending effects a company’s growth and profitability in US-based publicly traded companies. The advancement of technology has increased the importance and amount of R&D even further than before. However, in spite of this to the researcher’s knowledge there have not been many studies with data from the 21st century. This work will present literature regarding the treatment of R&D expenses in financial statements, previous research regarding the treatment of R&D in financial statements, as well as its’ effect on firm growth and profitability. Finally a correlation analysis and multiple linear regression analyses will be conduct to find out the effects of R&D on growth and profitability.

The treatment of R&D in discussed with regards to the US GAAP, which contains the accounting principles that US-based companies have to abide to. Additionally, how R&D is treated in the IFRSstandards will be explained. Previous research regarding the treatment of R&D in financial statements is examined, as well as research concerning how R&D expenditure affects a firm’s growth and profitability. There is no unanimity on whether or not R&D spending should be capitalized or expenses. On the other hand, there is a clear consensus when it comes to the effect R&D has on the growth of a firm, the effect is positive. However, with regards to profitability, the views are not as identical, but the majority of the research does indicate that R&D spending should increase the profitability of a firm.

The data that is used in the study comes from the Compustat-database. The final sample includes 675 companies and 8100 firm-year observations from 2005-2016.

The growth of a firm is measured by revenue growth, while the profitability of a firm is measured using the earnings before interest and taxes -percentage (EBIT-%) and the return on assets (ROA). The measure for R&D spending is R&D-intensity, which is measured using the R&D spending of firms scaled to their revenue or total assets. The results from our analyses regarding firm growth indicate that higher R&D-intensity increases a company’s revenue growth. These results are congruent with the results from previous literature. However, the results concerning firm profitability are contrary to previous research. The results in this thesis indicate that higher R&D-intensity has a negative effect on profitability.