The stock market's valuationof R&D externalities

R&D, particularly basic research, is generally considered as a public good. It provides positive externalities to other firms. This article investigates rival firms' stock-price responses to an increase in the R&D expenditures of a firm. Examining firms in the pharmaceutical industry, we found that the market valuations of some rival firms benefit from R&D externalities. Moreover, the cross-sectional analysis indicated that R&D-intensive firms benefit immensely from them. From this result, investors might assess that these firms have the full potential to absorb new R&D knowledge.