Activity Overinvestment: The Case of R&D

Abstract

The literature on corporate diversification has argued for and established the case that companies overdiversify in a product market sense (i.e., enter into unrelated product markets where they may not fully cover their cost of capital). Yet even without engaging in unrelated diversification, managers need to make resource allocation decisions in a variety of activities that a company conducts to consummate its business. In this article, we focus on R&D activity, and we discuss the effects that the uncertainty, boundary ambiguity, feedback latency, R&D lumpiness, and legitimacy that characterize technological contexts can have in making overinvestment in R&D likely. Specifically, in this article we (a) draw attention to the construct of activity overinvestment, and specifically R&D overinvestment; (b) use the received literature to argue that there exists a prima facie case for examining this construct and its antecedents in order to evaluate the extent and implications of R&D overinvestment; and (c) make the more general case that the resource allocation literature needs to study the issue of activity overinvestment systematically.