2.1. R&D Investment and Firm Performance
Researchers have examined the effects of R&D expenditures on firm performance. Previous studies that investigate the effects of R&D expenditures on firm performance show conflicting results. Chauvin and Hirschey (1993) [
15] argue that firms pursue technology innovation through R&D investment, which leads to revenue generation through new product development and positively affects profitability. They also argue that R&D investment has a positive impact on the profitability of the firm by improving production efficiency due to cost reduction. Bublitz and Ettredge [
4] also argue that R&D expenditures increase firm’s innovation activities, which has a positive (+) impact on sales growth. Lejarraga and Martinez-Ros (2014) [
16] argue that decision-making style during the R&D process depends on firm size, and that decision-making style ultimately affects the scale and quality of the innovative output.
In the Korean capital market, researchers examine the relationship between R&D expenditures and business performance. They provide evidence that there is a positive (+) relationship between R&D expenditures and business performance. On the other hand, Choi and Kim (2011) [
8] divide R&D expenditures into capitalized R&D expenditures and costed R&D expenditures. They find that capitalized R&D expenditures have a negative (-) impact on future profit growth. Lee and Lee (2009) [
7] examine the relationship between R&D investment and financial performance in the IT service industry. They find that R&D investment and financial performance do not show a significant relationship.
Many previous studies provide evidence showing that R&D expenditures are positively associated with corporate performance [
5,
17,
18,
19], but there are studies that R&D expenditures have negative or no impact on corporate performance [
7,
8]. In prior studies, the reason why R&D investment had a conflicting effect on firm performance is that the internal and external determinants of R&D productivity differ among the firms under study.
2.2. R&D Investment and Earnings Uncertainty
In prior studies, R&D expenditures have implied future uncertainty [
3,
9,
20], and some studies have shown that uncertainty of R&D expenditures can vary depending on the situation and environment of the firm [
10,
21]. Kay (1988) [
3] describes four key characteristics of R&D investment. They are called time lag, costliness, uncertainty, and non-appropriability. The time lag means that the effect of R&D investment does not appear instantly but appears at a certain time lag. Costliness means that R&D requires a lot of funds. So, firms need to finance the necessary funds for continuous R&D investment. Uncertainty means that if the R&D investment fails, the amount spent on the investment becomes the sunk costs, which is a great burden on the firm. If the size of a firm is small, the negative impact of investment failure can be more significant. Non-appropriability means that one technology can be created or applied to another. This indicates that R&D investment affects not only technological innovation but also imitation activities of competitors. In other words, the outcome of innovation through R&D investment has a spill-over effect between industries or within industries.
Kothari et al. (2002) [
9] examine the effect of investment in R&D and tangible assets on earnings volatility as a proxy for future uncertainty. They find that both R&D and tangible investment have a positive (+) relationship with earnings volatility. They also find that R&D investment has more uncertainty than tangible investment. In the Korean capital market, researchers examine the relationship between R&D investment and future uncertainty. They provide evidence that there is a positive (+) relationship between R&D investment and future uncertainty [
18,
22].
As mentioned above, the uncertainty of R&D investment can vary depending on the situation and environment of the firm. Amir et al. (2007) [
10] carried out the study by dividing the industries into high-technology industries and low-technology industries, predicting that the effect of investment in R&D and tangible assets on the earnings volatility can vary depending on the industries. They find that investment in high-technology industries has a greater impact on earnings volatility than low-technology industries. Also, they find that the difference of earnings volatility between tangible assets investment and R&D investment in the high-technology industries became more apparent. This indicates that the uncertainty of R&D investment can vary depending on the industries. Yoo (2017) [
21] examines the effect of R&D investment on future earnings volatility by dividing the firms into leader-firms and follower-firms. She finds that the R&D investment of the leader-firms has a greater impact on future earnings volatility than the follower-firms. This seems to be due to the fact that the leader-firms are engaged in innovative R&D activities while the follower-firms are carrying out R&D activities for imitation.
2.3. R&D Investment and Market Response
In prior studies, studies on the relationship between R&D investment and market response can be divided into studies on value relevance and earnings response coefficient (hereafter ERC). Researchers measure value relevance using stock price or stock returns. The stock price has a problem of heteroscedasticity due to the difference of firm size, but stock returns are widely used in the study of value relevance because it has the advantage of mitigating the heteroscedasticity. They argue that the effect of R&D investment on value relevance can vary depending on the circumstances of the firm [
22,
23,
24]. Ho et al. (2006) [
23] argue that firms with high growth rates, large size, and low risk have high value relevance of R&D investment because they can secure funds easily. Lee (2010) [
24] finds that firms with high growth rates and easy access to external funding can continue to invest in R&D, which has a positive (+) effect on business performance. In a study by Chung and Park (2016) [
22], firms with high uncertainty show greater earnings persistence and growth due to R&D investment than those with low uncertainty. This suggests that R&D investment of firms with high uncertainty plays a role to continuously grow earnings.
The earnings response coefficient (ERC) is measured using the stock price response to unexpected earnings. The ERC is widely used to study the market reaction to firm’s financial information. Liu and Thomas (2000) [
25] argue that ERC is used as a measure of the usefulness of accounting information, in particular as a measure of the value relevance of earnings and earnings quality. In prior studies, researchers mainly studied factors that affect ERC. They find that firms with high earnings persistence have higher ERC [
26,
27]. And the earnings persistence is supported by sustainable growth potential of the company. This can be interpreted as a result of information on the earnings quality reflected in the capital market. In addition, other studies show that firms with higher debt ratios have lower ERC than those with lower debt ratios [
28], and firms with high scores from financial analysts have higher ERC than those with low scores from financial analysts (Imhoff, [
29]. In the Korean capital market, Lee (2013) [
30] examines the relationship between firm life cycle and ERC, expecting that the firm’s earnings quality will differ according to the firm life cycle. He finds that ERC at maturity stage is higher than that at other stages, and argue that ERC is determined by earnings persistence rather than earnings growth and earnings management. Based on the results of prior studies, it is judged that ERC can be used as a proxy to measure the degree of effect of R&D investment on market response.
2.4. Firm Life Cycle
Previous studies on the firm life cycle can be broadly divided into studies on measures of firm life cycle and those on the effect of firm life cycle on specific dependent variables. In the literature of firm life cycle, firms are known to show differences in management environment, organizational structure, and strategy by life cycle stage [
11,
12,
13,
14]. Anthony and Ramesh (1992) [
13] employ the four variables of dividend payout, sales growth rate, capital expenditure, and firm age to distinguish four stages of firm life cycle: introduction, growth, maturity, and decline. Dickinson (2011) [
14] identifies each stage of the firm life cycle based on cash flow. He distinguishes five stages of firm life cycle: introduction, growth, maturity, renewal, and decline through the combination of the three cash flow (operating activities, investing activities, and financing activities) patterns.
The characteristics of four stages of firm life cycle are summarized as follows. The introduction stage is a time when firms first enter the market, and there is a high uncertainty and risks in the business. This stage is also a time to invest a lot for future growth. The growth stage is a time when firms grow and competitors emerge. This stage requires a strategy to survive the competition, and is also a time when innovation activities take place. The mature stage is a time when competition is fierce, and firm’s sales and business expansion are stagnant. So, this stage is a time when firms need to be more discriminating to get out of competition. Finally, the decline stage is a time when the growth of industry stagnates or declines. This stage is the time when firms are pursuing a withdrawal or recovery strategy [
12,
13,
14].
Meanwhile, previous studies analyzing the effect of firm life cycle examine the effect of the characteristic of each stage of it on the dependent variables. Dependent variables include various topics such as value relevance, profitability, accruals, earnings management behavior, conservatism, cost stickiness, and management control systems. Adizes (1979) [
11] has analyzed R&D behaviors of firms at different organizational life cycle stages. Kwon and Moon (2009) [
31] examine whether the effects of return on equity (ROE) and its components on future profitability and value relevance depend on the firm life cycle. They find that the usefulness and value relevance of current profitability at growth stage are lower than those at mature stage, while the usefulness and value relevance of current profitability at decline stage are higher than those at mature stage. Park and Park (2010) [
32] find that earnings persistence, ROE, and value relevance of accounting earnings at mature stage are higher than those at growth (or decline) stage, and financial risk and value relevance of net asset at mature stage are lower than those at growth (or decline) stage. Some studies provide empirical evidence that firms manage the earnings downward at the growth and mature stage, and manage the earnings upward at the decline stage [
33,
34]. Also, Kim and Yang (2012) [
35] provide evidence that the growth stage has greater cost stickiness than the other stages. Based on the results of prior studies, since the situation and environment of the firm are different according to the firm life cycle, the effect of R&D investment is expected to be different by firm life cycle.
2.5. Research Hypotheses
R&D investment has a positive effect of improving future management performance through technological innovation and new product development [
15]. Also, R&D investment has a negative effect of increasing future uncertainty due to characteristics such as time lag, costliness, and non-appropriability [
3]. Many previous studies provide evidence showing that R&D expenditures are positively associated with corporate performance [
5,
17,
18,
19], but there are studies that R&D expenditures have negative or no impact on corporate performance [
7,
8]. In previous studies, it appears that R&D expenditures have a conflicting effect on future performance because researchers did not properly reflect the environment and circumstances of the firms.
In relation to the effect of R&D expenditures on future management performance, we expect that the situation and environment of the firm will be different according to firm life cycle as follows. The introduction stage is a time when firms first enter the market, and there is a high uncertainty and risks in the business. This stage is also a time to invest a lot for future growth. In other words, since the performance of R&D investment appears with time lag, the R&D investment at the introduction stage has characteristics that are difficult to be connected directly with the management performance. The growth stage is a time when the effect of R&D investment in the introduction stage begins to appear as management performance. The growth stage is a time when firms grow and competitors emerge. Firms in the growth stage seek a strategy to continuously invest in R&D to improve the potential competitiveness of the firm. The mature stage is a time when competition is fierce, and a firm’s sales and business expansion are stagnant. So, this stage is a time when firms need to be more discriminating to get out of the competition. The mature stage is also a time when extra funding is created and the benefits of innovation are increased [
36,
37]. Therefore, the mature stage can have the strongest effect of R&D investment. Finally, the decline stage is a time when the growth of industry stagnates or declines. This stage is the time when firms are pursuing a withdrawal or recovery strategy [
12,
13,
14], so the effect of R&D investment is minimal.
As discussed above, since the firm life cycle reflects the situation and environment of the firms, the four stages of firm life cycle have a different impact on the relationship between R&D investment and future performance. Therefore, we set Hypothesis 1 as follows to investigate whether firm life cycle affects differentially the relation between R&D investment and future performance:
Hypothesis 1 (H1). The effect of R&D investment on future management performance will vary by firm life cycle.
Next, we investigate the uncertainty of R&D investment. Kothari et al. (2002) [
9] provide evidence that R&D investment has greater future uncertainty than investment in tangible assets. Amir et al. (2007) [
10] also provide evidence that in industries with high R&D intensity, R&D investment has greater future uncertainty than investment in tangible assets, while in industries with low R&D intensity there is no difference between the two. In previous studies, it appears that R&D expenditures have a conflicting effect on future uncertainty because researchers did not properly reflect the environment and circumstances of the firms. This implies that the uncertainty of R&D investment may vary depending on the environment and circumstances of the firm.
In the literature of firm life cycle, firms are known to show differences in management environment, organizational structure, and strategy by life cycle stage [
11,
12,
13,
14]. The uncertainty of R&D investment in introduction stage is high because the company is entering the market for the first time. In addition, it is the first stage of R&D investment, and it is expected that the burden of sunk cost in the failure of R & D investment will be bigger than other life cycle. Growth stage firms are larger than those of the introduction stage firms, and risk of failure to enter the market or invest in R&D is reduced. Therefore, the future uncertainty of R&D investment is expected to be small. In the mature stage, securing extra funds is easy, and competition is at its most intense. This is the phase in which innovation is pursued with extra funds to obtain differentiation from competitors [
12]. Also, the mature stage is the period when investment for strengthening IPRs is actively carried out. If the investment for strengthening the IPRs is done above the appropriate level, the resources will be wasted and the future profitability will be deteriorated. As a result, corporate R&D investments are likely to increase future uncertainty if they do not meet the eligibility criteria. The decline stage is not a time to pursue innovation, but rather to maintain existing policies and use recovery and withdrawal strategies. As a result, the uncertainty about the R&D investment in decline stage is expected to be small.
As discussed above, since the firm life cycle reflects the situation and environment of the firms, the four stages of firm life cycle have a different impact on the relationship between R&D investment and earnings uncertainty. Therefore, we set Hypothesis 2 as follows to investigate whether firm life cycle affects differentially the relation between R&D investment and earnings uncertainty:
Hypothesis 2 (H2). The effect of R&D investment on earnings uncertainty will vary by firm life cycle.
Finally, we investigate the market response of R&D investment. Researchers measure market response using stock price or stock returns. They argue that the effect of R&D investment on value relevance can vary depending on the circumstances of the firm [
22,
23,
24]. Ho et al. (2006) [
23] argue that firms with high growth rates, large size, and low risk have high value relevance of R&D investment because they can secure funds easily. Lee (2010) [
24] finds that firms with high growth rates and easy access to external funding can continue to invest in R&D, which has a positive (+) effect on business performance. In addition, ERC is widely used to study the market reaction to the firm’s financial information. Liu and Thomas (2000) [
25] argue that ERC is used as a measure of the usefulness of accounting information, in particular as a measure of the value relevance of earnings and earnings quality.
Meanwhile, the improvement of future performance has a positive (+) relationship with firm value, and the increase of future uncertainty has a negative (−) relationship with firm value. Analysts focus on the sustainable growth when assessing firm’s intrinsic value in the capital market. This implies that R&D investment affects the capital market through investors’ future expectations for sustainable issue.
The effect of R&D investment on future management performance and uncertainty is expected to be different for each stage of the firm life cycle as described in Hypothesis 1 and Hypothesis 2. The R&D investment of the introduction period is not easily connected with the performance and it is expected that the sunk cost will be bigger when the R & D investment fails. As a result, the R&D investment in introduction period is expected to show negative (−) signs on the market response due to the decrease in future management performance and the increase in uncertainty. The growth stage is the period in which the effect of R&D investment in the introduction phase begins to appear as business performance. Uncertainty is expected to be small because the risk of failure to enter the market or R&D investment is reduced compared to the introduction period. As a result, the R&D investment in the growth period is expected to show a positive (+) sign on market response because the growth of the future management performance and uncertainty are expected to be small. R&D investment can have a positive impact on future profitability in mature stage. However, if the R&D investment does not meet the eligibility criteria, it is likely to increase future uncertainty. As a result, investment in R&D in the mature period can be insignificant in terms of market response due to an increase in future management performance and an increase in uncertainty. The decline stage is the period of establishing a business withdrawal or recovery strategy [
12,
13,
14]. The impact of R&D investment on future profitability and uncertainty is expected to be minimal. As a result, the effects of R&D investment on market response are negligible because of the small effect on business performance and uncertainty.
Therefore, we set Hypothesis 3 as follows to investigate whether firm life cycle affects differentially the relation between R&D investment and market response:
Hypothesis 3 (H3). The effect of R&D investment on market response will vary by firm life cycle.