The second mover advantage: R&D and absorptive capacity

We examine the effect of absorptive capacity (AC), the extent to which a firm can translate R&D spillovers from its technological counterparts into its own productivity, on equity returns. We find that AC is a strong, positive predictor of future returns for small firms. We find that the higher returns earned by small firms, with high AC are positively related to recently developed long-horizon mis-pricing factors but not to standard risk factors. In addition, this effect remains significant after controlling for firm characteristics and other documented links between firms that forecast returns. Finally, our results are incremental to other documented R&D underpricing factors.