The return on R&D versus capital expenditures in pharmaceutical and chemical industries

The impact of research and development (R&D) on firm performance is generally agreed to be positive, but the nature and extent of this impact share little agreement in the previous research. Using an improved, time series, cross-sectional regression model that accounts for both contemporaneous and firm-specific serial correlation, as well as the feedback between firm profitability and investments, our study compares the rate of return from a dollar investment on R&D to a dollar investment on fixed assets in pharmaceutical and chemical industries. We find positive associations of R&D intensity and all variables of firm performance (net margin, operating margin, sales growth, and market value). We find that an investment in R&D earns an operating margin return much higher than the industry cost of capital. We also find that the effect of an investment in R&D on the firm's market value is about twice as much the effect of an investment in fixed assets. These findings have implications for corporate investment strategies, indicating that additional R&D investment is more likely to provide a firm with a unique and sustainable competitive advantage.

[1]  Jora R. Minasian.  The economics of research and development , 1960 .

[2]  Edwin Mansfield,et al.  Basic Research and Productivity Increase in Manufacturing , 1980 .

[3]  F. M. Scherer,et al.  The lag structure of returns to research and development , 1982 .

[4]  S. Dugal,et al.  Revisiting Corporate R&D Spending During a Recession , 1995 .

[5]  Z. Griliches.  Research Costs and Social Returns: Hybrid Corn and Related Innovations , 1958, Journal of Political Economy.

[6]  J. Barney.  Firm Resources and Sustained Competitive Advantage , 1991 .

[7]  Henry G. Grabowski,et al.  A New Look at the Returns and Risks to Pharmaceutical R&D , 1990 .

[8]  Z. Griliches.  Market Value, R&D, and Patents , 1981 .

[9]  Samuel B. Graves.  Institutional Ownership and Corporate R&D in the Computer Industry , 1988 .

[10]  Ryuhei Wakasugi,et al.  R&D, Firm Size and Innovation Outputs: Are Japanese Firms Efficient in Product Development? , 1997 .

[11]  Dennis C. Mueller,et al.  Industrial Research and Development, Intangible Capital Stocks, and Firm Profit Rates , 1978 .

[12]  Karel Cool,et al.  Asset stock accumulation and sustainability of competitive advantage , 1989 .

[13]  Graham K. Morbey,et al.  R&D: Its relationship to company performance , 1988 .

[14]  Jonathan N. Katz,et al.  What To Do (and Not to Do) with Time-Series Cross-Section Data , 1995, American Political Science Review.

[15]  Meir Statman.  Competition in the Pharmaceutical Industry: The Declining Profitability of Drug Innovation , 1983 .

[16]  Charles P. Himmelberg,et al.  R&D and internal finance: a panel study of small firms in high-tech industries , 1994 .

[17]  Zvi Griliches,et al.  Issues in Assessing the Contribution of Research and Development to Productivity Growth , 1979 .

[18]  Sundar G. Bharadwaj,et al.  Information Technology Effects on Firm Performance as Measured by Tobin's q , 1999 .

[19]  R. Grant.  The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation , 1991 .

[20]  Alexander Hicks,et al.  Politics, Institutions, and Welfare Spending in Industrialized Democracies, 1960–82 , 1992, American Political Science Review.

[21]  Frederic M. Scherer,et al.  Corporate Inventive Output, Profits, and Growth , 1965, Journal of Political Economy.

[22]  David H. Gobeli,et al.  Managerial Incentives, Internalization, and Market Valuation of Multinational Firms , 1998 .

[23]  A. Jaffe.  Technological Opportunity and Spillovers of R&D: Evidence from Firms&Apos; Patents, Profits and Market Value , 1986 .

[24]  Ben S. Branch.  Research and Development Activity and Profitability: A Distributed Lag Analysis , 1974, Journal of Political Economy.

[25]  B. Lev,et al.  The capitalization, amortization, and value-relevance of R&D , 1996 .

[26]  Martin Neil Baily,et al.  Research and Development Costs and Returns: The U.S. Pharmaceutical Industry , 1972, Journal of Political Economy.

[27]  M. Porter.  What is strategy , 2000 .

[28]  Stephen C. Vogt.  The Cash Flow/investment Relationship: Evidence from U.S. Manufacturing Firms , 1994 .

[29]  Fred C. Pampel,et al.  Relative cohort size and fertility: the socio-political context of the easterlin effect , 1993 .

[30]  Edwin Mansfield,et al.  Industrial Research and Technological Innovation: An Econometric Analysis , 1968 .

[31]  G. Erickson,et al.  Gaining comparative advantage through discretionary expenditures: the returns to R&D and advertising , 1992 .

[32]  Robert A. Connolly,et al.  R&D, Market Structure, and Profits: A Value-Based Approach , 1984 .

[33]  Cheng Hsiao,et al.  Formulation and estimation of dynamic models using panel data , 1982 .

[34]  Merrill S. Brenner,et al.  Sales Growth and R&D in the Chemical Industry , 1989 .

[35]  A. Sapienza.  Setting the record straight: The office of technology assessment report—pharmaceutical R&D costs, risks, and rewards , 1993 .

[36]  Steven B. Perfect,et al.  Alternative constructions of Tobin's q: An empirical comparison , 1994 .

[37]  R. Hall.  The strategic analysis of intangible resources , 1992 .

[38]  R. Parks,et al.  Efficient Estimation of a System of Regression Equations when Disturbances are Both Serially and Contemporaneously Correlated , 1967 .

[39]  H. Grabowski,et al.  Returns to R&D on new drug introductions in the 1980s. , 1994, Journal of health economics.

[40]  Stephen W. Pruitt,et al.  A Simple Approximation of Tobin's Q , 1994 .

[41]  John E. Jankowski.  R&D: Foundation for Innovation , 1998 .