How does the stock market respond to R&D cuts used to manage earnings?
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Date
2016-10-27
Authors
Li, Zhaochu
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon
Abstract
Prior research shows returns are positive when firms meet or beat analysts’ consensus forecasts but negative when firms miss. Past studies also show managers frequently cut R&D expenses in order to meet the consensus forecast. Despite these findings, there is limited evidence about how the market responds when firms beat the forecast by cutting R&D. This study shows the stock market penalizes firms that use R&D cuts to manage earnings and exacts a discount to the market reward if beating the forecast requires cutting R&D. The discount is only partial and firms are still better off doing so in the short run. Furthermore, this study shows the R&D cuts used to manage earnings are concentrated in specific industries and are likely temporary, as firms tend to increase R&D spending in the subsequent period. Investors appear to recognize these short-term cuts and treat them similar to accruals.
Description
Keywords
Earnings management, Managerial myopia, R&D