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Discretionary Capitalization of R&D - The Trade-Off Between Earnings Management and Signaling

50 Pages Posted: 1 Oct 2008 Last revised: 15 Aug 2014

Tami Dinh

University of St. Gallen, Institute of Accounting, Control, Auditing

Helen Kang

UNSW Australia Business School, School of Accounting

Wolfgang Schultze

University of Augsburg

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2009

Abstract

We analyze the trade-off between the benefits of signaling and the distortions from opportunistic earnings management resulting from the discretionary capitalization of Research & Development (R&D) expenditures. The latter can be used by managers to signal private information to the market. It can however also be used for opportunistic earnings management. Based on signaling theory, we argue that the market may use an overall assessment of earnings management to identify R&D capitalizations which are credible signals of future economic benefits. Based on Subramanyam 1996 who analyzes the pricing of discretionary accruals in general, we provide evidence that the pricing of the R&D accrual in particular is conditional on the company's degree of earnings management. Using German data for 2001-2006 we find that the market prices the R&D accrual only when the level of earnings management the firm is engaged in is low. In the spirit of Oswald (2008) we detect determinants of R&D capitalization and additionally distinguish between fundamental factors (firm size) and opportunistic determinants (profitability, leverage, accounting uniformity, and total R&D) that are indicative for managers' opportunistic behavior.

Keywords: Accruals, Cluster Analysis, Earnings Management, Research & Development, Value Relevance

JEL Classification: C29, G15, M41

Suggested Citation

Dinh, Tami and Kang, Helen and Schultze, Wolfgang, Discretionary Capitalization of R&D - The Trade-Off Between Earnings Management and Signaling (January 30, 2009). AAA 2009 Mid-Year International Accounting Section (IAS) Meeting Paper. Available at SSRN: https://ssrn.com/abstract=1275785 or http://dx.doi.org/10.2139/ssrn.1275785

Tami Dinh (Contact Author)

University of St. Gallen, Institute of Accounting, Control, Auditing ( email )

St. Gallen, 9000
Switzerland

HOME PAGE: http://www.aca.unisg.ch/en

Helen Hyon Ju Kang

UNSW Australia Business School, School of Accounting ( email )

Sydney, NSW 2052
Australia
+61 2 9385 5824 (Phone)
+61 2 9385 5925 (Fax)

Wolfgang Schultze

University of Augsburg ( email )

Augsburg, 86135
Germany

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