JSPES, Vol. 28, No. 3 (Fall 2003 )
pp. 295-323

Management Turnoverand Under-Investment in R&D: An Agency Theory Explanation for Under-Investment in Research and Development in some Corporations

Robert S. Graber

This paper provides an agency theory explanation for the apparent managerial myopia that is present in many corporations in the United States. The underlying premise of this research is that corporate managers may not really be short-sighted, but are in fact acting in what they perceive as their personal long-term best interests, rather than taking actions aimed at maximizing shareholders' wealth. Corporate managers may recognize, based on the experience of their predecessors, that their expected longevity with their current employers is limited. Therefore, they are likely to be reluctant to undertake any activities that will be costly to the firm in the short run, and can be expected to enrich the company only after a long period of time, when they may no longer be with their employer to share the rewards.

This research focuses on R&D because R&D expenditures are quantifiable, and because R&D expenditures are reported in the financial statements of publicly traded companies. However, the same arguments should be expected to be applicable to under-investment in other long-term ventures, such as employee training and the development of new markets.

The hypothesis of this study is that, all other things being equal, the greater the rate of turnover of senior managers, the smaller the percentage of revenue that a firm will invest in research and development. Management and CEO stock ownership can be expected to have a mitigating effect, since the greater the percentage of the firm that is owned by management, the more management's incentives should be aligned with those of other shareholders.

This study treats firm size and industry group as control variables. It was assumed that R&D investment decisions are likely to differ in different industries, and that firms of different sizes are likely to behave differently.

In general, the results support the hypothesis that there is an inverse relationship between management turnover and R&D investment as a percentage of revenue. Out of a sample of 200 firms, the smallest 50 firms proved to be most sensitive to CEO turnover. Among the smaller firms the R&D/revenue ratio was either very high or very low. Among the 100 larger firms, the R&D/revenue ratio seemed to be most sensitive to turnover during the 1980s, rather than to more recent turnover.

Overall, these results seem to suggest that substantial investment in long-term ventures, such as research and development, is most likely to occur when there is the expectation of continuity among senior managers.