Capitalizing Research & Development: Signaling or Earnings Management?

51 Pages Posted: 4 Mar 2014 Last revised: 10 Mar 2015

See all articles by Tami Dinh

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: February 15, 2015

Abstract

This paper analyzes the capitalization of Research & Development (R&D) expenditures under IFRS. Discretionary R&D capitalization can be exercised by managers to signal private information on future economic benefits to the market. It can, however, also serve as opportunistic earnings management. We analyze a unique, hand-collected sample of highly R&D intensive German firms reporting under IFRS during 1998-2012. We find that market values are not associated with capitalized R&D for the overall sample, indicating that earnings management may be a concern. We identify firm-years for which R&D capitalization is possibly used for pushing their earnings above a specific threshold (e.g. analysts’ forecasted earnings, prior year’s earnings). Our results show that both the decision to capitalize and how much to capitalize are strongly associated with benchmark beating. Consistently, we find that market values are negatively associated with capitalized R&D for firms who are likely to use capitalization for benchmark beating (about one third of the overall sample). On the other hand, the market values R&D capitalization positively for well-performing firms, for which capitalizing does not matter to beat an earnings benchmark (about half of the overall sample). This finding is robust to controls for endogeneity, various deflators, and different measures for earnings management.

Keywords: Research & Development, Earnings Management, Intangibles, Value Relevance

JEL Classification: M40, M41

Suggested Citation

Dinh, Tami and Kang, Helen Hyon Ju and Schultze, Wolfgang, Capitalizing Research & Development: Signaling or Earnings Management? (February 15, 2015). European Accounting Review Forthcoming. Available at SSRN: https://ssrn.com/abstract=2404296 or http://dx.doi.org/10.2139/ssrn.2404296

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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