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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27470
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| Title: | R&D Reporting Biases and their Consequences |
| Authors: | Lev, Baruch
Sarath, Bharat
Sougiannis, Theodore |
| Issue Date: | Jun-2004 |
| Series/Report no.: | Baruch Lev-10 |
| Abstract: | The immediate expensing of R&D expenditures is often justified by
the conservatism principle. However, no accounting procedure
consistently applied can be conservative throughout the firm' life. We
ask the following questions: (a) When is the expensing of R&D
conservative and when is it aggressive, relative to R&D
capitalization? and (b) What are the capital market implications of
these reporting biases? To address these questions we construct a model
of profitability biases (differences between reported profitability
under R&D expensing and capitalization) and show that the key
drivers of the reporting biases are the differences between R&D
growth and earnings growth (momentum), and between R&D growth and
return on equity (ROE). Companies with a high R&D growth rate
relative to their profitability (typically early cycle companies) report
conservatively, while firms with a low R&D growth rate (mature
companies) tend to report aggressively under current GAAP. Our empirical
analysis, covering the period 1972-2003, generally supports the
analytical predictions. In the valuation analysis we find evidence
consistent with investor fixation on the reported profitability
measures: we detect undervaluation of conservatively reporting firms and
overvaluation of aggressively reporting firms. These misvaluations
appear to be corrected when the reporting biases reverse from
conservative to aggressive and vice versa. |
| URI: | http://hdl.handle.net/2451/27470 |
| Appears in Collections: | Accounting Working Papers
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