The Influence of Corporate Internal Governance on the Wealth Effect of R&D Expenditure Increases

1. The Influence of Corporate Internal Governance on the Wealth Effect of R&D Expenditure Increases Shao-Chi Chang National Cheng Kung University, Taiwan Sheng-Syan Chen National Taiwan University, Taiwan Wen-Chun Lin National Cheng Kung University, Taiwan

2. Motivation • Investments in R&D are major sources of inputs for growth and competitive power • The evidences for the wealth effect of R&D investments are mixed • Positive (Chan, Martin, and Kensinger, 1990) • Insignificant (Sundaram, John, and John, 1996)

3. Difficulties in R&D Valuation • Information asymmetry • Not required to disclose information of R&D projects • To value R&D projects is difficult • The benefits of R&D last long-run period • To require R&D to be expensed is unsuitable

4. Motives for R&D Expenditure Increases • Tool of earnings management • To change the timing of R&D spending • Agency costs • To invest in unprofitable projects

5. The Benefits of Internal Governance • To reduce information risks • To disclose credible information • To control the level of earnings manipulation • To reduce agency costs • To cut down the inefficiency investments

6. Purpose +

7. Sample Design • Sample period: 1988-2001 • Announcement collected from Dow Jones News • Database: CRSP, Compustat, Compact D, SEC proxy statement • Final sample size: 243 announcements

8. Table 1 - Sample Distribution

9. Abnormal Returns • Standard event-study method • Use CAR (-1,0) to capture the wealth effects • Table 2 – the market response to R&D expenditure increases announcements.

10. Table 2 - Sample Statistics

11. Measures of Internal Governance • Board Characteristics • Fraction of outside directors • Board size • Ownership Structure • Blockholder ownership • Insider ownership • Leadership Structure • Duality

12. Board Characteristics • Outside director on the board • Serve a useful monitoring function. (Weisbach, 1988) • Board size • Larger board is valuable for the breadth of its services. • Smaller board is manageable and plays a controlling function. (Jensen, 1993) • Optimal board size should be neutral to firm performance. (Lehn, Patro, and Zhao, 2004)

13. Ownership Structure • Blockholder ownership (Allen and Phillips, 2000) • more incentive to monitor management • more ability to take the cost to monitor • Insider ownership (Cho, 1998) • optimally diversify risk

14. Leadership Structure • Duality : chairman of the board and CEO is same person • Disadvantage of duality • To impair the monitoring function of a board (Lehn and Zhao, 2006) • To increase the agency problems (Fama and Jensen, 1983)

15. Table 2 - Sample Statistics

16. Table 3 - Abnormal Return for Subsamples Based on Internal Governance (I)

17. Table 3 - Abnormal Return for Subsamples Based on Internal Governance (II)

18. Joint effect of Growth Opportunity and Internal Governance

19. Table 4 - Joint effect of growth opportunity and Internal Governance (I)

20. Table 4 - Joint effect of growth opportunity and Internal Governance (II)

21. Table 4 - Joint effect of growth opportunity and Internal Governance (III)

22. Control Variables

23. Table 5 - Impact of Internal Governance on CAR

24. Table 6 - Interaction Impact of Growth Opportunity and Internal Governance

25. Conclusions and Contributions • Internal governance has a impact on the valuation of R&D investments. • Internal governance and growth opportunity jointly decide the value creation of R&D investments • Internal governance explains the puzzle on the wealth effect of R&D expenditure increases

26. Thanks for your attention!