Conservative Accounting and the Pricing of Risk: The Case of Research and Development
36 Pages Posted: 25 Jul 2017
Date Written: July 21, 2017
We propose and test an economic channel through which conservative accounting conveys information on the resolution of cash flow uncertainty and systematic risk related to research and development (R&D) expenditure. By expensing R&D, conservative accounting aims to convey information about the stage of uncertainty resolution and the term-structure of uncertain expected earnings. Our analysis establishes a link between reported information on R&D activity, equity duration and discount rate risk within an Intertemporal Capital Asset Pricing (ICAPM) framework. Consistent with our predictions, we find that equity duration and discount rate betas are higher for R&D intensive firms. In contrast, cash flow betas do not depend on R&D intensity. Our results also suggest that the equity market prices the systematic risk associated with R&D.
Keywords: R&D, Conservative Accounting, Duration, ICAPM, Discount Rate Beta, Cash Flow Beta.
JEL Classification: G12, G14, M40, M41, N22
Suggested Citation: Suggested Citation