at the company level about intangible assets. He then discussed what kinds of information investors need and how it can be generated. The most basic theme of his remarks was that, in capital markets (unlike life in general), no news is bad news. Without information about an asset or an investment, it will be heavily discounted, or people will simply walk away from it.

Trends in Research and Development Investment

Lev noted that studies consistently show that stock shares of intangible-intensive companies are systematically undervalued. When shares are undervalued by investors, the cost of capital for these companies is excessive, and the consequence is a suboptimal level of investment in intangibles. This can lead to substandard growth, adverse effects on employment, and even to excessive insider trading gains at research and development (R&D)-intensive companies.

Lev next illustrated some of these points using examples from his research. One study (Lev, Nissim, and Thomas, 2007) used a methodology that is commonly used in finance and economic research and in capital markets themselves to identify undervaluation or overvaluation of securities. The methodology involves ranking securities by a piece of information that, a priori, is suspected to be either overappreciated or underappreciated by investors; subsequent risk-adjusted returns on the portfolios of these securities are then examined. If investors, on average, properly price securities based on known information, there is no way, months or years after that, to gain or lose from this information. This is a clear and very powerful test of whether securities are mispriced relative to specific information.

Figure 4-1 aggregrates into three categories a ranking of about 1,600 companies on the basis of R&D capital spending relative to total assets. The ranking is based on information published in the income statements of the companies. The risk-adjusted rates of return, subsequent to the ranking of 3 years of data, have been estimated for each company for the past 25 years. Stocks of companies with large R&D capital (depreciated) have systematic growth in rates of return, risk adjusted, of about 15 percent by about the 20-month mark. This is, by Lev’s assessment, an abnormally high rate of return, which means that, at the time the companies were ranked when financial reports came out, investors systematically undervalued large R&D capital and overvalued low R&D capital. This, reported Lev, is consistent across practically every study with which he is familiar.

He then pointed out other studies that directly estimate the cost of capital for R&D-intensive companies. Almost all of them reveal substantially higher costs of debt for the R&D-intensive companies relative to other companies. As an aside, R&D is the only intangible investment that is reported by companies separately in financial reports, which makes it easier to do research on it. All other investments, things like software and branding, tend to be buried in larger cost items, which make it difficult to disentangle the data to do firm-level research. Lev also



The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement