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

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)

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

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

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

Purpose +

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

Table 1 - Sample Distribution

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.

Table 2 - Sample Statistics

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

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)

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

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)

Table 2 - Sample Statistics

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

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

Joint effect of Growth Opportunity and Internal Governance Internal Governance (IG) High IGLow IG Growth Opportunit y (q) High q(+)(.) Low q(.)(-)

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

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

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

Control Variables DefinitionSign SIZEFirm size- IRI Industry R&D intensity + FRI Relative firm R&D intensity + IC Industry concentration + Pseudo q Growth opportunity +

Table 5 - Impact of Internal Governance on CAR

Table 6 - Interaction Impact of Growth Opportunity and Internal Governance

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

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