Effect of R&D on Tobin’s q (Case Study)

A.               Explain how any intangible capital effects of R&D intensity can reflect the effects of market power and/or superior efficiency.

B.               A multiple regression analysis based upon the data contained in Table 12.3 revealed the following (t statistics in parentheses):

                               q   =  1.740 + 0.041 Profit Margin + 0.018 Growth - 0.421 Beta + 0.057 R&D/S

                                         (2.33)   (1.74)                          (0.31)               (-1.43)             (2.15)

R² = 41.1%, F statistic = 4.36

Are these results consistent with the idea that R&D gives rise to a type of intangible capital?

CASE STUDY SOLUTION

A.               Intangible R&D capital can be derived from the value obtained from patents and other monopoly protections offered to firms making significant new discoveries and innovations.  Alternatively, significant R&D capital can result from the unpatented advantages gained from effective basic research and applied development.  In economic terminology, superior rewards earned from exceptional productive capability or superior efforts are called Ricardian rents after the early British economist David Ricardo.  Monopoly rents which are usually regarded as unjust compensation for the antisocial exercise of market power through high prices.  Richardian rents are conventionally regarded as fair compensation for a superior productive capability that results in higher revenues or lower production costs.  To the extent that the firm possesses factors which increase revenues or lower costs relative to the marginal firm, it will persistently display q > 1.  To the extent that productive R&D allows the firm to increase revenues and/or lower costs, and thereby persistently display q > 1, the firm can be said to possess significant unmeasured intangible R&D capital.

                  It is worth noting that this study compares a stock measure, the market value of the firm, with the flow of R&D expenditures.  On a theoretical basis, it would seem more appropriate to compare market values with the stocks of intangible capital tied to R&D.  However, if economic amortization of the exponential decay type can be assumed, along with constant percentage rates of growth in R&D expenditures, then the magnitude of intangible capital equals annual expenditures on R&D multiplied by a constant.  Given these assumptions, the stock of intangible R&D capital is strictly proportional to the flow of R&D expenditures, and the net income and stock-price effects of R&D expenditures can be taken as indicative of intangible capital influences.

B.               Yes, these results are consistent with the idea that R&D gives rise to a type of intangible capital.  On an overall basis, the simple model estimated here explains more than one-third (41.1%) of the variation in Tobin’s q ratio seen for the giant corporations included in the DJIA.  This is a statistically significant explanation (F = 4.36) of a meaningful share of q variation.

                 Positive and statistically significant stock-price effects of net profit margins reflect the effects of superior efficiency and/or market power. Because effective R&D can be expected to enhance both current and future profitability, the marginal effect of R&D intensity on Tobin’s q is a very conservative estimate of the total short-term plus long-term value of R&D when such impacts are considered in conjunction with the stock-price effects of current net profit margins.  For this sample of firms, revenue growth fails to exhibit the expected positive effect on market values, but influences of risk are found using stock-price beta.  With an increase in risk, the market value of expected returns appears to fall, as anticipated.

               Interestingly, R&D intensity appears to have a consistently positive effect on the Tobin’s q, even after allowing for the market value-effects of current profit margins.  These results are consistent with the hypothesis that R&D makes an important contribution to the long-term profitability of the firm, and gives rise to a type of “intangible capital” with long-lived influences.  In considering the economic determinants of Tobin’s q it is important that the effects of superior efficiency or capability be separated from the simple influences of market power.  More detailed consideration of the favorable long-term effects of R&D is a small step in this direction.