R&D, IP, and firm profits in the automotive supplier industry

Economic theory implies that research and development (R&D) efforts increase firm productivity and ultimately profits. The effects of R&D investments on productivity have long been the focus of research. There exists consensus theoretically that R&D investments increase productivity both in the aggregate and on the firm level and that is generally confirmed by empirical studies; see e.g. Griliches (1998) and Mairesse/Sassenou (1991) for an overview. However, due to conceptual problems with the central R&D capital model (based on production functions) and econometric problems such as endogeneity and data heterogeneity, much of the empirical work thus far presented remains controversial; see e.g. Griliches (1998), chapter 12.

This investigation does not try to identify the underlying production function but focuses instead on the profit and return structure resulting from earlier monetary and tangible capital formation treating the residual difference between the total value of assets of the firm and the sum of monetary and tangible assets as IP capital. Total return to all assets is then decomposed using the weighted average cost of capital concept to yield a residual return on the IP asset.

In particular, R&D expenses are expected to lead to the development of intellectual property (IP) and IP commands a return that increases overall profits of the firm. This hypothesis is investigated for the European American automotive supplier industry by analyzing a panel of European firms for the years 1985 to 2010.

Results indicate that R&D expenses in fact increase profitability at the firm level. In particular, increases in the R&D expense to sales ratio lead to increases in the profit contribution of intangible assets relative to sales. This indicates that more R&D intensive IP should command higher royalty rates per sales when licensed to third parties and within multinational enterprises alike.

JEL classification: D24, L20, L62, M21

Keywords: productivity, intellectual property, royalties, MNE, transfer pricing