Investments in research and development (R&D) drive innovation and economic growth. To stimulate innovation and encourage increasing investments in R&D, the federal government offers R&D tax credits. Beyond tax savings, R&D tax credits signal critical information about the quality of a firm’s investments in innovation, especially at initial public offering (IPO).

A study published in the Journal of Accounting & Economics by Mays Business School faculty Dr. Bradford F. Hepfer, associate professor and Deborah D. Shelton Professor in Taxation at Texas A&M University’s Mays Business School, along with Dr. Hannah W. Judd, assistant professor at Brigham Young University’s Marriott School of Business who earned her Ph.D. from Mays, and Dr. Sarah C. Rice, associate professor and Deborah D. Shelton Accounting Systems Professor at Mays, investigates how firms at IPO use R&D tax credit disclosures to signal innovation investment quality. The findings reveal that these credits not only reduce IPO underpricing but also increase investor demand, highlighting their strategic value beyond direct tax savings.

R&D Tax Credits as Signals of Innovation

For IPO firms, information asymmetry poses a significant challenge. Investors often lack the information to evaluate the quality of a firm’s innovation activities. Public disclosure of R&D tax credits serves as a signal of the quality of investments in innovation, helping to bridge this information gap without revealing sensitive information about innovation activities. The study reveals that IPO firms disclosing R&D tax credits, on average, experience 8.2 percentage points less underpricing and raise $7 million more in IPO proceeds. These additional IPO proceeds equate to 32 to 45 percent of creditable R&D expenditures, demonstrating the economic significance of the R&D tax credit as an information signal.

The nontax benefits of R&D tax credits extend beyond IPO proceeds. Firms that claim these credits also demonstrate stronger innovation performance in the years following their IPOs. They secure more patents, receive more patent citations, and outperform in the stock market.

Implications for Firms, Policymakers, and Investors

The study offers insights for firms navigating IPOs. R&D tax credit disclosures not only reduce investor uncertainty but also bolster a firm’s reputation as an innovation leader. By strategically highlighting these credits, IPO firms can reduce underpricing, secure higher proceeds, and position themselves as forward-looking and dynamic.

Policymakers, too, can benefit from understanding the broader implications of R&D tax credits. While these incentives were originally designed to encourage investments in R&D, the credit’s role as a signal of innovation extends its value.

For investors, R&D credit disclosures provide a valuable lens for assessing a firm’s innovation potential. This signal helps investors identify companies with robust innovation pipelines and long-term growth prospects, enabling more informed investment decisions.

A Strategic Tool for Innovation and Growth

The dual role of R&D tax credits — as tax incentives and strategic signals — underscores their importance in today’s innovation-driven economy. By bridging information gaps, these credits help firms to attract investors and achieve better IPO outcomes. The findings of the study serve as a reminder of the interconnectedness of tax policy, corporate strategy, and market perceptions.

Firms that effectively use R&D tax credits can position themselves as leaders in innovation, building trust and driving long-term growth. Similarly, policymakers and investors who understand the multifaceted benefits of these credits can contribute to a more dynamic and resilient economic ecosystem.

This research provides a compelling case for recognizing R&D tax credits as more than just a tax-savings mechanism. R&D tax credits also offer a lens into corporations that foster innovation, which reduces investor uncertainty and improves capital markets.

Key Research Takeaways

1. Lower IPO Underpricing: Firms that disclose R&D tax credits during their IPOs experience an 8.2 percentage point reduction in underpricing, allowing them to capture more value during the offering.
2. Higher IPO Proceeds: These firms raise an average of $7 million more in IPO proceeds, with additional funds amounting to 32-45% of their creditable R&D expenditures.
3. Enhanced Innovation Indicators: Firms claiming R&D credits post-IPO demonstrate higher patent counts, increased patent citations, and stronger one-year-ahead stock performance, signaling robust innovation potential.
4. Both Tax and Nontax Benefits: R&D tax credits serve a dual purpose: reducing tax costs and acting as a signal to investors, which improves investor information of firms’ innovation capacity and potential.