R&D expenditures and firm profitability – Evidence from the U.S. and Europe

Abstract

Europe’s innovation gap in terms of R&D spending relative to the U.S. is well-documented, however, few empirical studies analysing the drivers behind this gap exist. We contribute to the literature by examining, whether lower R&D profitability in Europe compared to the U.S. explains the divergence in R&D spending. Using a data set of 48,851 firm-year observations from the U.S. and 15 developed European countries, we find that R&D profitability has declined both in the U.S. and Europe between 1990 and 2020 and that R&D profitability is significantly higher in Europe, indicating that profitability issues do not explain the gap in R&D spending. Additionally, we show that higher R&D intensity combined with diminishing marginal returns, the higher composition of STEM companies (sector composition effect), a combination of firm characteristics (younger and smaller firms), and lower financial constraints contribute to the lower R&D profitability in the U.S.