The negative impact of R&D capitalization: A value relevance approach

Abstract

Accounting for R&D costs is an open issue. SFAS N°2 mandates that all R&D costs must be immediately expensed. IAS 38 requires capitalization of R&D costs if they meet certain criteria. Recent research papers show the value relevance of capitalized R&D. We test the value relevance of R&D reporting in a sample of 197 French firms between 1993 and 2002. The French context provides an interesting field for R&D value relevance studies because both accounting treatments of R&D costs (expensing and capitalization) are allowed. Unlike previous studies, we find that capitalized R&D is negatively associated with stock prices and returns. This negative coefficient on capitalized R&D implies that investors are concerned with and react negatively to capitalization of R&D. We also find that the firms choosing to capitalize (successful) R&D are smaller, more highly leveraged, less profitable and have less growth opportunities. Taking into account these characteristics, our robustness checks confirm that capitalized R&D is not associated with higher prices and is related to lower returns.

Acknowledgements

The present paper was made possible by financial support from the ESSEC Business School Research Centre. We thank seminar participants at the 2003 EAA annual congress, the 2003 FRBC annual conference at Cardiff Business School and the 2003 Workshop on Capital Market Research in Accounting. We are also grateful to Ann Gallon for editing and to Christophe Danset for research assistance.

Notes

1. IAS 9 (1993), ‘Research and development costs’, was replaced by IAS 38 in July 1999.

2. Note that the avis 2004-15 issued by the Conseil National de la Comptabilité (Accounting National Council) in June 2004 proposes new rules that are very similar to IAS 38 for R&D reporting, but will become compulsory only from 2005 if approved by the Comité de Réglementation Comptable (French Accounting Regulation Committee).

3. Note that EPS = ΔBVPS, and BVPS = ABVPS + RDCapPS, so EPS = ΔABVPS + ΔCapRDPS, moreover, ΔABVSP = AEPS, eventually we get EPS = AEPS + ΔCapRDPS.