R&D investment and risk in Brazil

This study evaluates whether the undervaluation of R&D firms, as observed in developed markets, is due to mispricing or to risk adjustment for innovative activity. Analyzing stocks listed on the São Paulo Stock Exchange from 2006 through the first half of 2014, we compare returns to portfolios of firms differing in industry-adjusted R&D intensity (IRDI), without and with controls for risk (modeled in two ways). Our results indicate that a long-short strategy of buying stock in high-IRDI firms and short-selling stock in low-IRDI firms provides a significant abnormal return of 4.78% per year without controls for risk; after various risk factors are controlled, the return rises to 5.16% or 5.28%, depending on how risk is modeled. These results suggest that investors undervalue companies that invest more than their industry's average in R&D, and that the abnormal returns cannot be attributed to systematic In fact, cross-sectional regressions show that firms with greater IRDI are less risky than those with low intensity, exhibiting lower future volatility in the three years after the R&D investment. In addition, using the number of analysts as a proxy for investor attention, we show that companies with high IRDI that also provide more information to the market about their innovation projects can mitigate approximately 40% of their potential undervaluation.