The Effect of Research and Development (R&D) Investments on the Firm Financial Performance

Abstract

This study explores the effect of research and development (R&D) investments on the financial performance of firms listed on the Pakistan Stock Exchange (PSX) from 2005 to 2021. Using a dynamic panel dataset of 51 publicly traded companies from different industries, the research employs a two-step System Generalized Method of Moments (System GMM) estimation to tackle potential endogeneity, firm-specific differences, and dynamic feedback effects. Financial performance is measured through both accounting indicators (Return on Assets, ROA) and market indicators (Tobin’s Q). The empirical findings show a dual pattern: R&D intensity negatively affects short-term profitability (measured by ROA), likely because of immediate costs and how R&D expenses are accounted for. At the same time, R&D intensity has a positive and significant impact on long-term market value (as indicated by Tobin’s Q), which reflects investor optimism and the strategic importance of innovation. These results highlight the trade-off faced by R&D-active firms between short-term operational efficiency and long-term growth. The study also finds that firm size enhances the positive effects of R&D, while financial leverage decreases both operational and market performance. The findings add to academic literature (e.g., Alam et al., 2020; Khan et al., 2019; Shahbaz et al., 2021) and provide practical insights for corporate managers, investors, and policymakers seeking to align innovation strategies with sustainable financial success.