Narrative R&D Disclosure and the R&D Anomaly

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2019-08-30
Authors
Baik, Bok
Farber, David
Kim, Sunghyo
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Prior research documents that investors underreact to R&D expense because they have difficulty valuing innovation (Chan et al 2001; Eberhart et al. 2004; Cohen et al. 2013). This phenomenon is commonly referred to as the R&D anomaly. We extend prior research by examining how narrative R&D disclosure in 10-K filings impacts market participants’ understanding of the value of innovation. We first show that narrative R&D disclosure is positively related with future R&D outcome. Despite such value-relevance, we find that R&D anomaly is magnified in intense narrative R&D disclosure firms, as reflected in larger future returns associated with current R&D expense. We further find that the impact of R&D disclosure on the R&D anomaly is more pronounced when the number of investors’ 10-K views is low and when 10-K reports are less readable. Overall, our findings suggest that narrative R&D disclosure does not necessarily help investors’ ability to impound information about R&D into stock prices on a timely basis. Our study has implications for regulators in that users of financial statements have difficulty processing on a timely basis the information contained not only in R&D, but also in R&D narrative disclosure.
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R&D, Textual analysis, Mispricing, Narrative disclosure
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