UC Berkeley

Focusing on high-technology issuers, this study provides new evidence that managers strategically overinvest in research and development (R&D) projects prior to seasoned equity offerings (SEOs). It corroborates the theoretical prediction that managers with short-term valuation pressure tend to overinvest in long-term projects to elevate investors’ growth expectations (Bebchuk and Stole, 1993). I find that issuers with more intensive pre-SEO R&D expenditures exhibit lower productivity in terms of innovative output and operating performance following offerings, which is a primary manifestation of overinvestment. Such issuers also have higher price run-ups prior to offerings and lower long-term stock returns thereafter, suggesting that investors initially overestimate the future benefits of R&D expenditures but are subsequently disappointed by their low productivity. In additional analysis, I document that analysts make higher long-term growth forecasts prior to offerings for R&D intensive issuers, whereas such issuers are more likely to miss analysts’ sales forecasts subsequently relative to non-intensive issuers. This evidence suggests that analysts fare no better than investors in correctly anticipating the future benefits of pre-SEO R&D expenditures. Further analysis of managers’ disclosure of the intended use of proceeds indicates that R&D intensive issuers tend to provide more non-financial R&D information to reinforce investors’ growth expectations. Finally, I provide evidence that the documented strategic R&D investment behavior among seasoned issuers is not explained by managerial overconfidence.