An Econometric Analysis of the Causal Relationship between R&D Intensity and Firm Valuation in the Technology Sector

Abstract

Employing an econometric modeling strategy, this paper aims to explore, in the context of the technology industry, the impact of R&D intensity in the form of expenditure to revenue ratio on the valuation of (R&D) expenditure, represented by Tobin's Q. This relationship is often assumed to be positive; however, establishing a causal relationship is complicated by the presence of endogeneity (i.e. reverse causality, omitted variable bias, etc.). In this regard, we estimate R&D and valuation in technology sector firms using the dynamic panel GMM on a balanced panel of publicly traded technology companies for the years 2013-2023. This technique effectively accounts for the unobserved firm-level heterogeneity and the valuation of firms' metrics. As a result, there is a clear and sound positive causal relationship whereby a 1% augmentation in R&D expenditure intensity increases the valuation of a firm by approximately 0.15%. Furthermore, to a certain (very high) extent, this relationship is non-linear and characterized by a diminishing return on R&D. In firms with high/strong intellectual property portfolio, particularly patent citations, the market impact of R&D valuation is greater. This work provides a resource-based and innovation literature perspective; the positive valuation of R&D investment clearly identifies the mechanism of value-creation R&D resource allocation. Analysts have seen value in these for corporate strategists in capital allocation decisions, and for those investors trying to understand the worth of intangible assets in high-tech companies.