The Association between the Uncertainty of Future Economic Benefits and Current R&D and Capital Expenditures: An Industry Analysis

Since 1974, R&D expenditures have been fully expensed when incurred partly because R&D activities were allegedly associated with a high degree of uncertainty in future economic benefits. In this paper, we estimate the association between R&D expenditures and capital expenditures (CAPEX) and the variance of future earnings per share, operating income and sales. We conduct this experiment by industry and show that R&D expenditures lead to higher volatility of future earnings than capital expenditures only in R&D intensive industries, where industry R&D intensity is measured as the R&D-to-CAPEX ratio. We also find that the stronger association of R&D with uncertainty in future earnings is a recent phenomenon due to the advance of the information technology revolution. This revolution has had only modest effect on R&D activities in other industries. In addition, we find weaker evidence that R&D expenditures lead to higher volatility of future sales, an alternative measure of future economic benefits. Finally, we show that in industries that are relatively less dependent on R&D activities, the probability of recovering R&D expenditures is similar to that of capital expenditures. Overall, our results suggest that while some industries engage in a more innovative and uncertain R&D activities, R&D in other industries is less uncertain. These results support the claim that a uniform expensing rule may not accurately reflect underlying economic relations.