R&D intensity, development costs' capitalization intensity and stock returns: a variance decomposition analysis

This study examines the value relevance of R&D intensity and development costs’ capitalization intensity under IFRS, by gauging their contribution to the informational components of the volatility of unexpected returns. We use a multivariate time-series approach that can be reconciled to a log-linear valuation model by also accommodating time-varying discount rates. Our results show that R&D intensity has a significant positive impact upon the variance contribution of cash flow and accrual news to the variance of unexpected returns. Thus, R&D intensity indeed conveys value relevant information about shocks to both future operating cash flows and accruals. We also show that this association is stronger as the capitalization intensity of development costs increases, but only for accrual news. Overall, the return decomposition that we employ shows the channel through which the return variation related to R&D and development costs’ capitalization intensity occurs. Additional analysis shows that our results are not driven by country level growth option risk but are weaker in countries with higher uncertainty avoidance. This study contributes to the R&D and return variance decomposition strands of the literature and raises policy implications by providing evidence in favour of development costs’ capitalization.