Creative destruction in R&D: On the relationship between R&D expenditure volatility and firm performance

A common perspective is that consistent research and development facilitates innovation and enhances firm performance, while R&D volatility provides evidence of myopic strategic decisions by managers. This dissertation develops an alternative perspective that focuses on R&D manager entrenchment, the capital budgeting process, and the nature of innovation. Successful firms may follow a creative destruction approach that relies on proactive R&D management to identify and terminate underperforming R&D projects, leading to volatile R&D expenditures.;In an initial study, these competing theoretical perspectives are empirically tested on research and development volatility using a large cross-section of firms from 1995 to 2004. Consistent with the creative destruction hypothesis, evidence suggests that research and development volatility is positively related to several different proxies of R&D success and to firm performance. Other results suggest that the most successful firms are able to reduce funding to under performing projects, limiting overinvestment in research and development. Overall, this analysis suggests that steady R&D expenditures, instead of facilitating technological innovation, may indicate managerial entrenchment and overinvestment.;In addition, this dissertation considers whether the firm's capital structure, level of diversification, and the level of organizational slack influence the relationship between R&D expenditure volatility and firm performance. Empirical analysis yields strong support for the proposition that munificent industries, low levels of leverage, low levels of diversification and high levels of organizational slack are important enablers of the positive link between R&D expenditure volatility and firm shareholder value. Despite a plethora of theoretical and anecdotal evidence that organizational slack can enhance firm innovation, this is one of the few research contributions providing empirical evidence that helps to describe how slack actually contributes to innovation. This study extends our insights on the important role that industry context and firm structure plays in the innovation process.;Finally, evidence suggests that this proactive R&D management approach drives a particular form of innovative activity. In order to permit creative destruction to operate in the R&D lab, management must possess the technological domain expertise that enables them to identify and terminate underperforming R&D projects while funneling resources into those projects with the best commercial prospects. Firms also must maintain adequate monitoring of R&D projects that enables them to identify lagging projects in a timely and accurate manner. Using data from a cross-section of large manufacturing firms from 1984 to 1999, a third study finds that firms with higher levels of R&D expenditure volatility have higher levels of technological domain expertise, and locate their R&D knowledge creation activities in clustered geographic areas. Firms that frequently and substantially adjust their R&D expenditure have superior knowledge endowments, and higher levels of project monitoring, that enable them to discriminate between good and bad R&D projects. Overall, this final set of results suggests that firms with volatile R&D expenditures generate incremental innovation.