Nonlinear Effects of R&D Intensity on Short-Run Profitability: Evidence from Firm-Level Panel Data

Abstract

Using a firm-level panel dataset, this study examines the short-term relationship between innovation investment and firm performance in the pharmaceutical industry. The study investigates whether R&D intensity has a linear or nonlinear impact on returns on capital employed (ROCE), drawing on the literature on the innovation–profitability trade-off. The analysis accounts for time-specific shocks and unobserved firm heterogeneity using a fixed-effects model with firm-clustered standard errors and lagged R&D intensity. The findings show that R&D intensity and profitability have a statistically significant nonlinear (convex) relationship. Higher levels of innovation investment mitigate the marginally negative effect, indicating the presence of learning effects and scale economies, even though initial increases in R&D intensity lower short-term financial performance. The industry's capital intensity pressures are indicated by the negative relationship between firm size and ROCE, with lifecycle effects playing a supporting role. The results point to the dynamic adjustment process that underlies innovation investment and imply that long-term R&D tactics could lessen immediate financial strains. Overall, the study adds to the body of literature by showing that nonlinear adjustment, as opposed to a straightforward linear trade-off, characterises the innovation–performance nexus.