Improving Investment Efficiency: The Case of R&D Capitalization

• In Event: Investment Behavior

Abstract

This paper investigates the impact of an accounting rule, permitting the capitalization of research & development costs (R&D), on investment efficiency (under-/over-investment). Prior research suggests that rules mandating the immediate expensing of R&D costs can lead to under-investment in settings where managerial myopia is likely to be present. Using a sample of R&D intensive companies from the UK that are subject to IAS 38 allows us to investigate whether permitting capitalization mitigates against under-investment; or indeed encourages over-investment. Our findings suggest that the capitalization option mitigates against under-investment related to managerial myopia (i.e. avoiding losses and earnings decreases). However, it can encourage over-investment for firms with high financial slack. We also find evidence of over-investment in firms with high leverage calling into question the “disciplining role” of leverage in the context of R&D. Our research contributes to the debate on accounting for self-generated intangibles focusing on real investment effects.

Authors

• Tami Dinh Thi, The University of New South Wales

• Baljit K Sidhu, The University of New South Wales