Researcher ORCID Identifier

0000-0002-1978-9908

Graduation Year

2022

Date of Submission

4-2022

Document Type

Open Access Senior Thesis

Award

Robert Day School Prize for Best Senior Thesis in Economics and Finance

Degree Name

Bachelor of Arts

Department

Economics

Reader 1

Darren Filson

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Terms of Use for work posted in Scholarship@Claremont.

Rights Information

@ 2022 Dustin S Lind

Abstract

Cohen et al. (2013) measure a firm’s ability at investing in knowledge capital, a type of intangible capital, through a model that captures how well a firm translates R&D intensity into future sales growth. Using this model, they show that an investment portfolio comprised of firms that have high R&D spending ability and high R&D intensity earn significant positive abnormal returns. I modify their model to capture a broader investment in intangible capital by replacing R&D intensity with SG&A intensity and substituting sales growth with gross profit growth. My measure of ability at investing in intangible capital has two main advantages over Cohen et al.’s (2013) measure. The first advantage is that it can be applied to a larger sample of firms. This is because current US accounting standards give firms discretion over how they report their R&D spending – a proxy for investments in knowledge capital – so many firms do not report this expense separately from SG&A despite evidence of intangible capital creation. The second advantage of my model is that it considers the simple fact that investments can result in revenue generation and/or cost savings, both of which are valuable to a firm. Cohen et al.’s (2013) measure depends on sales growth, so it does not consider firms that are successful at converting intangible capital investments into cost savings. In performing a calendar-time portfolio analysis using my SG&A spending ability measure, I find strong evidence that, on average, firms that have a track record at effectively investing in intangible capital (demonstrate a high ability while also investing heavily in this area) experience positive abnormal returns. Namely, an equal-weighted long portfolio strategy that invests in firms that score in the top quintile of effectiveness has four- and five-factor alphas (using the factors suggested by Carhart 1997 and Fama and French 2016) of 68 (t = 4.023, p < 0.001) and 68 basis points per month (t = 3.868, p < 0.001), respectively, which both translate to annual abnormal returns of roughly 8.5%. I also construct a version of my ability measure that depends on sales growth, instead of gross profit growth and find that this specification is not a strong predictor of abnormal returns. Lastly, I perform two additional calendar-time portfolio analyses, sorting firms into portfolios by R&D intensity and Cohen et al.’s (2013) original measure of R&D spending ability as well as a modified ability measure that depends on gross profit growth. I find that I am unable to replicate Cohen et al.’s (2013) findings using an updated sample. Additionally, I find that portfolios sorted on an R&D spending ability measure that depends on gross profit growth produce abnormal returns. However, because these portfolios have a small number of stocks these abnormal returns could be due to firm-specific idiosyncratic shocks.

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