Friday, October 9, 2015

R&D Spending: Dynamic or Persistent?

PENNETIER Christophe, GIROTRA Karan, MIHM Jürgen
Read the working paper
INSEAD Working Paper 2015/77/TOM

It is well established that the benefits of R&D spending accrue over several years and that more cumulative R&D spending benefits the firm more. Here we study how a given amount of R&D spending is best allocated over time to optimize R&D performance. Under a persistent policy, allocations remain nearly constant irrespective of circumstances; under a dynamic policy, R&D spending increases (resp., declines) when opportunities arise (resp., fail to materialize). We use a sample of 3,746 publicly listed companies, observed for an average of seven years between 1982 and 2003, to assess which of these two R&D allocation policies is preferable. We find that a dynamic allocation strategy is associated with worse R&D performance—in terms of patent quantity and quality—and demonstrate that momentum is not the cause. We find that it is particularly the unpredictable part of any dynamic spending pattern that hurts R&D performance; the predictable part has no or even positive effects. Finally, our results are more pronounced for firms in higher quantiles of the performance distribution: rather than coping with the negative effects of dynamic allocation, such companies are especially affected by them.