Capitalization of R&D and the Informativeness of Stock Prices

39 Pages Posted: 1 Sep 2007

See all articles by Dennis R. Oswald

Dennis R. Oswald

University of Michigan - Ross School of Business

Paul Zarowin

New York University (NYU) - Department of Accounting

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Abstract

This paper presents both a new approach to studying the consequences of accounting choice and a unique sample to examine the effects of accounting choice in the R&D context. We investigate the effect of firms' decision to capitalize R&D expenditures on the amount of information about future earnings reflected in current stock returns, as captured by the association between current-year returns and future earnings (FERC). We use a sample of U.K. firms, which includes both R&D capitalizers and expensers. An important feature of our tests is our use of a two equation system to control for the endogeneity of the accounting choice (i.e., self selection). Proponents of capitalization claim that it enables management to better communicate information about the success of projects and their probable future benefits. Consistent with this, we find that capitalization is associated with higher FERC than expensing.

Keywords: research & development, informativeness, capitalization

JEL Classification: M41, M44, M47, G12

Suggested Citation

Oswald, Dennis R. and Zarowin, Paul, Capitalization of R&D and the Informativeness of Stock Prices. European Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1011238

Dennis R. Oswald (Contact Author)

University of Michigan - Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109-1234
United States

Paul Zarowin

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street, Suite 400
422 Tisch Hall
New York, NY 10012-1118
United States
212-998-0015 (Phone)
212-995-4004 (Fax)

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