Reassessed Earnings with Capitalized Intangibles

Abstract

This paper examines whether and how the capitalization of in-house intangible investments would alter the assessment of firm profitability and the qualitative attributes of earnings. We find that the percentage of loss-reporting firms declines, and that earnings and operating cash flows dramatically increase. Reassessed profits and losses better map with positive and negative stock returns, respectively. Reassessed profits and losses also better map with firm survival and failure, respectively. Qualitative attributes of earnings improve—expenses are better matched with contemporaneous revenues, earnings become less volatile and more persistent, and the earnings-to-price ratios provide better signals for value investing. These findings suggest that capitalization of intangibles improves the assessment of firm profitability while enhancing the usefulness of earnings measures. However, caution is advised in interpreting these results because the greater likelihood of earnings management and the increased frequency of intangible impairments are not examined in this paper.

Keywords: intangibles, matching, earnings, financial statement analysis, valuation

JEL Classification: M13, M21, M41