The Second Mover Advantage: R&D and Absorptive Capacity

We examine the effect of absorptive capacity, the extent to which a firm can translate R&D spillovers from its technological counterparts into its own firm productivity, on firm returns. We find that absorptive capacity is a strong, positive predictor of future returns for small firms, after controlling for firm characteristics and risk. This effect remains significant after controlling for other documented links between firms that predict firm returns. We find that the small firms with high absorptive capacity earn higher returns that is incremental to existing, documented issues of R&D and returns predictability. The undervaluation is pronounced in firms which are more subject to low investor attention and have high cost of arbitrage. Our results identify absorptive capacity as a source of market under-reaction related to information in R&D investments.