-DR Anne CAZAVAN-JENY* Thomas JEANJEAN** Juillet 2003

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1 CENTRE DE RECHERCHE RESEARCH CENTER -DR Value Relevance of R&D Reporing : A Signaling Inerpreaion Anne CAZAVAN-JENY* & Thomas JEANJEAN** Juille 2003 * CAZAVAN-JENY A. ESSEC, Avenue B. Hirsch, BP 105, Cergy Ponoise Cedex, France. ** JEANJEAN T. Groupe HEC, 1, rue de la Libéraion, Jouy-en-Josas Cedex, France GROUPE ESSEC CERNTRE DE RECHERCHE / RESEARCH CENTER AVENUE BERNARD HIRSCH - BP CERGY-PONTOISE CEDEX FRANCE TÉL. : 33 (0) FAX : 33 (0) Mail : GROUPE ESSEC, ÉTABLISSEMENTS PRIVÉS D'ENSEIGNEMENT SUPÉRIEUR, ASSOCIATION LOI 1901, ACCRÉDITÉ AACSB - THE INTERNATIONAL ASSOCIATION FOR MANAGEMENT EDUCATION, AFFILIÉ A LA CHAMBRE DE COMMERCE ET D'INDUSTRIE DE VERSAILLES VAL D'OISE - YVELINES. WEB :

2 Value relevance of R&D reporing: a signaling inerpreaion Anne CAZAVAN-JENY* and Thomas JEANJEAN** * Assisan Professor, ESSEC Business School ** Assisan Professor, Groupe HEC Address for correspondence: Anne CAZAVAN-JENY, Assisan Professor ESSEC Business School, Deparmen of Financial & Managemen Conrol Avenue Bernard Hirsch B.P Cergy-Ponoise Cedex France Tel.: Fax.: Acknowledgemens The presen paper was made possible by financial suppor from he Research Cener of he ESSEC Business School, Paris (Cenre de recherche). We are graeful o Chrisophe Danse for research assisance. 1

3 Value relevance of R&D reporing: a signaling inerpreaion ABSTRACT Accouning for research and developmen (R&D) coss is an open issue. SFAS N 2 mandaes ha all R&D coss are immediaely expensed. Inernaional sandards prescribe a capializaion of R&D coss if hey mee cerain crieria (IAS 38). Recen research papers (Healy e al., 2002; Lev and Sougiannis, 1996, 1999; Aboody and Lev, 1998, Zhao, 2002) show ha capializaion of R&D coss and sofware developmen coss is value relevan. However criics can be leveled a previous research because prior empirical ess are based on simulaed or parial daa. Our purpose is o es empirically R&D accouning issues on a sample of 95 French firms on a hree years period ( ). French conex provides an experimenal field for sudying he value relevance of R&D capializaion, because boh accouning reamens of R&D coss (expensing and capializaion) are allowed. We find ha capialized R&D is posiively associaed wih sock reurns and sock prices, whereas expensed R&D is negaively relaed o sock prices and sock reurns. R&D accouning reduces he informaion asymmery on he successfulness of R&D projecs: i acs as a signal o invesors. This paper exends previous lieraure by using real daa on capialized R&D, insead of esimaed daa. Moreover, we show no only ha capialized R&D is value relevan bu also ha expensing of R&D projecs conveys a negaive signal. Key words : value relevance, R&D, France, financial reporing, capial markes, accouning choice. 2

4 0. INTRODUCTION This paper deals wih he value relevance of research and developmen (R&D) coss financial reporing. Accouning for R&D effors is an open issue. US sandard seers mandae ha all R&D coss are immediaely expensed (SFAS N 2), whereas Inernaional sandards prescribe a capializaion of R&D coss if hey mee cerain crieria (IAS 38). On one hand, proponens of he cos mehod argue ha expensing is preferable o capializaion because i eliminaes he opporuniy for managers o capialize coss of projecs ha have a low probabiliy of success or o delay wriing down impaired R&D asses. On he oher hand proponens of he capializaion mehod argue ha R&D oulays generae some of he mos prized economic asses in he economy. As Rimerman (1990) noes inangible, unmeasured asses have grea imporance in an economy increasingly dependan on experise, daa and echnology, an economy in which an expanding service secor does no rely on fixed asses as he primary generaor of revenue. As a consequence accounans refusal o capialize hese expendiures as asses seriously affecs he relevance of financial reporing. Lev and Sougiannis (1999) argue ha he significan decline in he relevance and he usefulness of financial saemens is due o he non recogniion of inangible asses in he balance shee. To summarize, he cos mehod is perfecly objecive and verifiable. The capializaion of R&D coss may be used o convey informaion bu is also less reliable. There is a rade off beween reliabiliy and objeciviy (Healy e al., 2002). This rade off is of imporance boh o marke paricipans and o sandard seers. For invesors, he financial reporing of research and developmen oulays has a grea impac on he repored ne income (if he R&D effor is no consan over ime). Moreover, a uniform way o repor for R&D expendiures (e.g. cos mehod) disallows ousiders o properly 3

5 evaluae he growh opporuniy se in a conex of informaion asymmery. For sandard seers, he accouning of R&D oulays is imporan as i relaes o heir concepual framework. According o boh he IASB and he FASB, financial repors should provide useful informaion o invesors. As a consequence, mos of he lieraure (wih some excepion, e.g. Boone and Raman, 2001) has concenraed on he value relevance of R&D accouning regimes (expensing or capializing). An implici assumpion of he value relevance approach is ha an accouning rule is preferred if i improves he saisical associaion of sock prices and/or reurns wih earnings, book values or oher accouning variables. In he case of R&D accouning, under he value relevance crierion, full cos accouning should be adoped only if he value relevance of earnings and book value is higher han under a recogniion of R&D oulays as asses. The empirical challenge for esing he value relevance of R&D regimes ress on he daa requiremens. Such ess require a se of daa wih capializers and expensers, bu mos sandard seers require he cos mehod. Researchers developed hree answers o his challenge: (1) The use of arificial daa: since capializaion of R&D coss is no allowed in he US, some auhors chose o model he amouns of capialized R&D. For insance, Lev and Sougiannis (1996), Horwiz and Zhao (1997) and Chambers e al. (1998) developed a model o price R&D asses if successful R&D oulays were capialized insead of being expensed. Healy e al. (2002) go even farher: hey use Mone Carlo simulaions o generae financial saemens of pharmaceuical firms. They were hen able o es he associaion beween economic values (ROE, ne presen value of he firms, ) and he R&D accouning reamen (full cos or successful effors). Overall, hose sudies documen he value relevance of capializing R&D coss. 4

6 (2) The use of real daa: Oher auhors prefer o use real daa o creae samples of capializers and expensers. For insance Aboody and Lev (1998) sudied sofware developmen coss capializaion, which is he only excepion in he Unied Saes o he full expensing rule of R&D. The disadvanage of his approach is a scope s reducion compared o he previous sudies. (3) A comparaive approach: Some auhors choose o implemen a comparaive approach. Since some accouning seers require full expensing of R&D expenses and oher auhorize capializaion, i is possible o carry ou value relevance sudies on a sample of inernaional firms. For insance, Zhao (2002) noes ha he USA or Germany require a full expense of R&D coss, whereas France or he UK allow a capializaion of such coss. Zhao (2002) compares he abiliy of accouning figures o explain share prices in hose counries. Overall, previous sudies conclude o a higher value relevance of capialized R&D coss if hey mee cerain crieria of successfulness insead of jus expensing hem. However, his conclusion is based on sudies ha can be criicized. The relevance of sudies wih arificial daa is based on he abiliy of he researcher o compue an economically sound asse of R&D. This abiliy can be quesioned. For insance, Lev and Sougiannis (1996) use polynomial Almon lag mehod ha is highly dependan on he number of observaions. The range of he papers on sofware developmen coss capializaion are oo narrow o be easily generalized. Finally, comparaive sudies fail o conrol he many biases ha can affecs he empirical findings (marke microsrucure, insiuional facors, he funcions of accouning across counries, ) 5

7 Our goal is o ake advanage of a specific feaure of he French insiuional conex. French sandard seers allow condiional capializaion of R&D coss or expensing of such R&D coss. French firms have he opion o choose he expensing or he capializaion of R&D oulays (under condiions). This framework provides a laboraory experimen for an accouning reamen of inangibles ha differs from he nearly universal full expensing of inangible asses. Under French GAAP, managers can signal o marke paricipans he expeced reurn of heir R&D oulays by capializing such coss 1. Since capializaion is an opion, managers can also align heir pracices on inernaional sandards and expense heir R&D oulays. This design offers a unique opporuniy o assess he value relevance of R&D accouning. More precisely, he issues raised by he value relevance of R&D accouning are wofold. Firs, do marke paricipans value R&D asses? This quesion is open due o he rade off beween relevance and reliabiliy. A posiive and significan associaion provides a srong suppor o he IASB posiion. Second, if he recogniion in he balance shee of R&D oulays is relevan, hen expensing R&D oulays should provide a negaive signal o he marke because unsuccessful invesmens can be expeced. Our research design is based on wo value relevance sudies (explanaion of he cross secional reurns and explanaion of he year-end share price). Our sample is composed of 95 French lised firms which disclosed informaion on R&D on he period. In France, he income saemen usually classifies expenses by naure raher han by funcion 2. R&D expenses, like adverising expenses, are herefore no shown in French Group financial saemens, in conras o he siuaion under US GAAP. The sample size is 254 observaions 1 Only he cos of successful projecs can be capialized. To capialized, R&D oulays mus mee hree crieria: o be specific o an idenifiable projec, o be relaed o applied research (fundamenal research is no eligible), o have significan chances of commercial success. Given he las condiion, only successful projecs can be recognized as asses. 2 Ding, Solowy and Tenenhaus (2002) show ha only 32 French companies, in he op 100, used he presenaion by funcion in

8 due o daa limiaions. Our empirical findings sugges ha capializaion of R&D coss is value relevan. The recogniion in he balance shee of such asses is perceived as a posiive signal by he marke. On he opposie, an expensing of R&D coss produces lower share prices and lower reurns (ceeris paribus). The reminder of he paper is organized as follows. Secion 1 describes our heoreical background, secion 2 presens our mehodology, secion 3 our empirical findings and secion 4 concludes. 1. THEORETICAL BACKGROUND 1.1. Accouning reamen of Research & Developmen coss Research and developmen reporing in French consolidaed saemen could follow differen GAAP (bu R&D reporing mus follow French accouning rules in he individual accouns). Wih he creaion of CRC (Comié de la réglemenaion compable, Règlemen 99-02), quoed companies could use eiher French rules or IAS GAAP or, unil he 31 s December 2002, inernaional GAAP as US GAAP. As shown in able 1, he accouning reamens of R&D coss are differen across sandards. Inser Table 1 French rules sae ha R&D expendiures are expensed as incurred unless he projec saisfies cerain condiions. PCG 99 (Plan compable général, 1999) express ha: Excepionally, applied research and developmen coss could be capialized if he projecs concerned are clearly idenifiable, heir respecive coss are disincly evaluaed, and each projec has a serious chance of echnical success and commercial profiabiliy (Ar ). Capialized R&D expendiures mus be amorized over a period no exceeding 5 years. There are no clearly esablished rules concerning he saring dae for amorizaion. In excepional circumsances, and relaing only o paricular projecs, R&D capialized expendiures may be 7

9 amorized over a longer period no exceeding he useful life of he asses. If R&D coss are expensed as incurred, hey shall be disclosed in he managemen repor 3. The capializaion of R&D coss under French rules remains an opion for he company if he projec saisfy he above crieria. Thus he capializaion of R&D coss is a sraegic decision for he group. The lieraure suggess ha when firms make reporing decisions, here is a rade-off beween he cos of revealing proprieary informaion and he resuling benefi (Verrechia, 1983). This rade-off is likely o be very sensiive in he case of R&D reporing because of is highly confidenial naure. On he oher hand, no choice of R&D accouning reamen exiss under US GAAP. SFAS N 2 esablished sandards of financial accouning and reporing for research and developmen (R&D) coss. This saemen requires ha R&D coss o be expensed when incurred. I also requires he company o disclose in is financial saemens he amoun of R&D expensed (i.e. here is no opional reamen of R&D coss, bu heir amoun is available). However, separae rules apply o developmen coss for compuer sofware ha is o be sold: capializaion (and amorizaion) applies once echnological feasibiliy is esablished. Capializaion ceases when he produc is available for general release o cusomers. Similar rules apply o cerain elemens of developmen coss for compuer sofware for inernal use (SFAS N 86). In conclusion, US GAAP do no allow capializaion of R&D coss, bu require a disinc disclosure of hese coss. 3 In France, he income saemen presenaion usually presens a classificaion of expenses by naure raher han by funcion. R&D expenses, like adverising expenses, are no herefore shown in French Group financial saemens, in conras o he siuaion under US GAAP. All inangible expendiure is disribued beween he various operaing expenses. For example, sofware developmen coss will be divided beween personnel coss for he employees who worked on he projec, purchases of raw maerials for any componens, and oher relevan iems in he same way. 8

10 A las, French lised companies could follow he inernaional sandards. The objecive of IAS 38 is o prescribe he accouning reamen for inangible asses ha are no explicily covered in anoher IAS 4. IAS 38 mandaes: a full expensing of all research coss (IAS 38.42). a capializaion of developmen oulays only if echnical and commercial feasibiliy of he asse for sale or use has been esablished. This means ha he firm mus inend and be able o complee he inangible asse and eiher use i or sell i and be able o demonsrae how he asse will generae fuure economic benefis (IAS 38.45) An inangible asse (i.e. capialized R&D) should be amorized over he bes esimae of is useful life (IAS 38.79). Neverheless, IAS 38 does no permi an enerprise o assign an infinie useful life o an inangible asse. I includes a presumpion ha he useful life of an inangible asse will no exceed 20 years. Impairmen (IAS 36) applies o inangible asses. There is a compulsory annual es if he amorizaion period exceeds 20 years or inangible is no ready for use. Finally, addiional disclosures are required abou he amoun of research and developmen expendiure recognized as an expense in he curren period (IAS ) Value relevance of R&D oulays French conex provides an experimenal field for sudying he value relevance of R&D capializaion, because boh accouning reamen of R&D coss (expensing and capializaion) are allowed. Zhao (2002) sudies he relaive value relevance of R&D capializaion in France, he UK, Germany and he USA. He shows ha he reporing of oal R&D coss increases he 4 IAS 9 (1993), «Research and developmen coss» was replaced by IAS 38 in July

11 associaion of equiy price wih accouning earnings and book-value wih complee R&D accouning sandards (Germany and he USA). The allocaion of R&D coss beween capializaion and expense provides incremenal informaion conen over he disclosure of he oal R&D coss. However, his sudy presens caveas due o he inernaional comparison. Recen comparaive sudies indicae ha earnings qualiy is subjec o several counry specific facors oher han legal sysems (e.g. Pope and Walker, 1999; Ali and Hwang, 2000). Zhao (2002) follows Francis and Schipper (1999) in examining only he informaion conen of R&D coss level. Lev and Zarowin (1999) find ha change in R&D inensiy bears significan addiional informaion and ha i is necessary o conrol for indusry effec in R&D accouning research because indusrial R&D is indusry specific by naure (Lev and Sougiannis, 1996). The relaion beween he sock reurns and invesmens in R&D has been exensively sudied in prior lieraure. For insance, Hirschey (1982) shows ha, on average, adverising expenses and R&D oulays have a posiive and significan effec on he share price. Connolly and Hirschey (1984) documen he same relaion beween R&D expenses and share price on a sample of 390 firms represening more han 90% of he R&D expense of he US indusrial firms. More recenly, Lev and Sougiannis (1996) documened a significan and iner emporal associaion beween a capial of R&D and fuure sock reurns. If R&D coss are relevan, some auhors sugges he exisence of a sysemaic mispricing of he inensive R&D firms, or of a compensaion wih a facor of risk. For insance, Chan e al. (2001) give suppor o his proposiion. They show ha R&D inensive firms have low pas reurns and show signs of mispricing. Overall, hese aricles show: a posiive link beween R&D expenses and various marke values. 10

12 ha marke paricipans percepion of R&D effeciveness is blurred by informaion asymmery. As consequence, R&D oulays are mispriced by he marke. These conclusions raise he quesion of he value relevance of R&D oulays reporing. Sandard seers may require ha all R&D be expensed immediaely or could auhorize a capializaion of R&D oulays under condiions. Capializaion (or expensing) of R&D effors is value relevan if a significan associaion is found wih marke values (share price or cross secional reurns for insance). Our research quesion is he following: Is i possible o convey informaion on R&D by reporing R&D as expenses or as asses? This quesion is no rivial due o he rade off beween relevance and reliabiliy in he case of R&D capializaion (Healy e al., 2002). As noed by Lev and Sougiannis (1996, 1999), R&D capializaion is probably relevan because i allows o reduce he informaion asymmery beween he firm and marke paricipans. Neverheless, capializing such coss also creaes an opporuniy for managers o engage ino earnings managemen. Recognizing R&D as asses may impair financial repors reliabiliy. Our goal in his paper is o ake advanage of he French local conex: - Since, French sandard seers auhorize he recogniion of R&D effors eiher as an expense or as an asse, we have he opporuniy o sudy he value relevance of each accouning reamen. - Compared o prior sudies, we have an access o real daa abou capialized R&D. As a consequence, we do no have o compue an esimaed R&D asse as in Lev and Sougiannis (1999) or in Lev e al. (2002). 11

13 - We also have he opporuniy o conrol he differences in accouning rules enforcemen or in marke microsrucure ha can impair he relevance of comparaive sudies (as in Zhao, 2002). Consisen wih prior sudies, we can sae he following hypohesis: H1: Recogniion of R&D oulays as asses is value relevan. We expec a posiive and significan associaion beween capialized R&D and marke values. Since French managers have he opion o recognize developmen coss as asses, recogniion as expense should signal non profiable or non achieved R&D projecs. We can sae H2: H2: Recogniion of R&D oulays as expense conveys a negaive informaion o he marke. We expec a negaive and significan associaion beween expensed R&D and markes values. 2. DATA AND METHODOLOGY 2.1. Sample To carry ou our research, we need o creae a sample of expensers and capializers among he French lised firms. The main difficuly was o idenify capializers because mos of he daabases use a US forma of balance shee, where R&D asses are no idenified. For insance, on he Thomson financial daabase, R&D asses are regisered as inangible asses (as wih brands, paens, oher inangibles). To idenify expensers, we use he Thomson financial daabase (who repors he amoun of R&D expensed). To idenify capializers, we use he DIANE (DIsque pour l Analyse Economique) daabase, specialized on French firms. Capialized R&D is repored on a specific line of he balance shee. Since here are doubs on he reliabiliy of his daa base, we cross checked he daa gahered from DIANE wih he informaion disclosed in annual repors. 12

14 95 large French lised firms compose our sample on a hree year period ( ). The oal sample size is 254 observaions (firm-year), which can appear o be quie small given ha 1,404 non financial firms are presen on he Thomson Financial daabase (able 2): our sample represen only 6.77% of he French lised firms. Inser Table 2 To explain his resul, i should be noed ha under French regulaions, firms do no have o disclose heir R&D oulays. As a consequence, our sample is biased owards firms wih an incenive o disclose addiional informaion. By comparing our sample wih he oal populaion of lised firms, we noe ha our sample is biased owards high echnology, high growh firm, small capializaion (see able 3). Inser Table 3 Since our sample is mainly compounded of high ech firms, we presen he descripive saisics for each sub sample (high ech versus radiional firms) in able 4. On he whole, his able suggess ha high ech firms have higher growh opporuniies (Price-Earnings-Raio is 32.5% versus 15.52% for radiional firms, Price-o-Book raio is 5.3 versus 2.8), are less leveraged (25% of oal asses versus 29.57%, significan a 5%), more risky (β is 1.30 versus 0.62 for radiional firms) and have smaller marke capializaion (5.7 billions of euros versus 8.9 billions) han radiional firms. Surprisingly he average R&D oulays per share (R&D per share) of high ech firms is no saisically differen from he average spending of radiional firms (RDPS: R&D per share) as shown in able 4. This resul is probably due o he sample bias (made of firms who volunarily disclosed informaion). However, as able 4 shows, high ech firms clearly choose 13

15 o capialize heir R&D oulays. This feaure of our sample is consisen wih prior sudies (Ding and Solowy, 2003). Inser Table Research design We examine he value relevance of R&D accouning reamen (expensed versus capialized) using wo approaches: associaing sock reurns wih conemporaneous financial daa and associaing sock prices wih financial daa. We conrol our models by he following variables coming from previous lieraure. Size, measured by he marke value of equiy a he end of fiscal year. Large firms end o spend a subsanial par of research and developmen coss on basic research, on mainenance and upgrades of heir producs. Theses coss, and paricularly basic research coss are expensed accordingly o PCG 99, IAS 38 or SFAS N 2. Consequenly, large firms are expeced o expense a larger par of developmen coss han smaller firms. Growh, measured by he annual change of sales. We expec ha firms having he higher level of growh are he mos engaged in R&D. ROE (Profiabiliy), measured by he raio reurn on equiy per share. Given analyss scepicism abou research and developmen capializaion, i is widely believed ha profiable companies avoid capializaion in order no o ain he perceived qualiy of heir earnings in analyss eyes. 14

16 Leverage, measured by long-erm deb divided by oal capial 5. Leverage is a proxy for he resriciveness of loan covenans as moivaors of capializaion; firms closer o loan resricions may favour capializaion which increases equiy and earnings. Sysemaic risk, or β. Basic research more risky han produc developmen. Basic research is also expensed according o French, inernaional or US GAAP, while produc developmen could be capialized. Thus riskier firms, namely, hose devoing a larger share of developmens effors o basic research, can be expeced o expense more han less risky companies. Book-o-marke raio, indicaes invesors growh expecaions irrespecive of when he underlying informaion reaches he marke. This raio allows o conrol for performance and risk (Fama and French, 1992). We expec firms wih high (low) book-o-marke raio have low (high) R&D inensiy Sock reurns model Firs we examine he link beween sock reurns, annual R&D capializaion and expensed R&D daa using a model derived from he Fama and French (1992) and Aboody and Lev (1998) models. The associaion beween capialized R&D variable and conemporaneous annual sock reurns indicaes he exen o which he informaion conveyed by R&D capializaion is used by invesors. Such a es canno indicaes wheher invesors acually used capializaion daa in assessing securiy values. We esimae he following cross secional regression: 5 Toal capial represens he oal invesmen in he company. I is he sum of common equiy, preferred sock, minoriy ineres, long-erm deb, non-equiy reserves and deferred ax liabiliy in unaxed reserves. 15

17 R = a 0 + a RDES 1 + a 2 RDCapTA + a 3 ln( Size) + a Growh 4 + a 5 ROE + a 6 Bea + a 7 Lev + a 8 ln( BTP) + a 9 HT + a 10 YR + ε (1) Wih, R i : annual sock reurn a he end of year for firm i. RDES i : annual amoun of expensed R&D coss o sales, for firm i and year. RDCapTA i : annual amoun of ne capialized R&D coss o oal asses, for firm i and year. Ln(Size i ): logarihm of marke value of he firm i a he end of fiscal year. Growh i : rae of growh for company measured as change in sales beween and -1. ROE i : reurn on equiy raio (earnings / book value) for firm i a he end of year. I measures he profiabiliy of he firm Bea i : measure of risk, CAPM-based bea of company i. Lev i : leverage raio for firm i in year, measured as long erm debs on oal capial. Ln(BTP i ): logaryhm of book value (minus capialized R&D) per share o price a he end of year. HT i : dummy variable for indusry group coded one for high-echnology firms and zero for radiional firms. YR i : ime indicaor variable ha equals o one if an observaion is from fiscal year Y, and zero oherwise. If he annual capialized R&D represens value relevan informaion o invesors hen a 2 in model (1) should be posiive. Since RDES is likely o include R&D expendiures incurred before echnical and/or commercial feasibiliy has been achieved, we predic a 1 o be negaive and smaller han a 2. 16

18 We assume ha while firms generally underake posiive expeced value projecs, achieving echnological or commercial feasibiliy (indicaed by capializaion) confirms o invesors ha he projec has a posiive expeced value. Whereas R&D expensed could be seen as non profiable or non achieved R&D projecs, which are no considered as vehicle for value creaion Sock price Model Model (1) deals wih he value relevance of he annual capialized and expensed R&D coss. To sudy he value relevance, in he associaion sense, of he R&D asse repored on he balance shee and he expensed R&D coss, we ran he following regression: P = b 0 + b RDEPS 1 + b 2 RDCapPS + b 3 EPS + b 4 BVPS + b 5 ln( Size) + b Bea 6 + b HT 7 + b YR 8 + ε (2) Wih, P : sock price a he end of he fiscal year for firm i. RDEPS : annual amoun of expensed R&D coss per share. RDCapPS : annual amoun of ne capialized R&D coss per share. EPS : repored annual earnings per share. BVPS : book value of equiy per share. Ln(Size i ), Bea i, HT i and YR i : as defined above. Model (2) was moivaed by recen empirical work on earnings models, in which he marke value of he company is regressed on alernaive measures of earnings, book value, and oher relevan informaion (Aboody and Lev, 1998, p. 172; Zhao, 2002, p.158). 17

19 3. EMPIRICAL FINDINGS 3.1. Univariae ess Firs, we carry ou a few univariae ess o check he value relevance of R&D accouning mehods. Table 5 shows ha no significan relaion can be found beween R&D oulays per share (RDPS = RDEPS + change in RDCapPS) and sock reurns, whaever may be heir recogniion in financial saemens (in he income saemen or in he balance shee). However, he posiive relaion beween price and R&D per share is posiive and no far from being significan a 5%. Inser Table 5 As able 5 shows he relaion beween price (P) and he R&D reporing is conrary o wha is expeced since RDCapPS (resp. RDEPS) is negaively (resp. posiively) relaed o price. The univariae correlaion beween RDCapTA (ne RD coss capialized) and reurn is significan and posiive as expeced, bu he correlaion beween RDES (RD expensed divided by sales) is no significan. Overall univariae ess indicae ha R&D reporing in he financial saemens maers o explain he cross secional variaion of reurns and he share price. However, he sign of he relaion is no clear due o high correlaion beween he financial reporing of R&D and growh opporuniies ha have an impac on share price or reurn. Table 6 and able 7 show ha correlaions beween R&D oulays and various measures of performance (probably relaed o share price and reurns) are significan. Thus, we have o carry ou mulivariae ess o conrol for poenial opposie effecs. Inser Tables 6 and 7 18

20 3.2. Mulivariae ess Value relevance analysis Table 8 represens he esimaes for he sock reurns regression, model (1), for he full sample (panel A), for he radiional firms (panel B) and for he high-echnology firms (panel C). Inser Table 8 In panel A (oal sample) he coefficien of annual capializaion of R&D (RDCapTA) has he expeced sign (2.544) and is highly saisically significan ( = 3.766). In addiion, as repored in panel C, he coefficien of capialized R&D is posiive and significan for high-ech companies and insignifican for radiional firms, as repored in panel B. In conras o he large and highly significan coefficien of he capialized R&D variable, he esimaed coefficien of expensed R&D coss (RDES) is negaive ( ), only significan a 10% (for panels A and C) and insignifican for panel B. Coefficiens for he size conrol variable, ln(size), are posiive and significan for he hree panels, whereas growh conrol variable presens a posiive associaion wih sock reurns only for he full sample and high-ech firms. Evidence from he sock reurn analysis indicaes ha invesors disinguish beween capialized and expensed R&D coss; while values of he former are posiively associaed wih sock reurns, values of he laer are negaively associaed. This resul indicaes ha capializaion of R&D is no a signal of earnings manipulaion, bu is a relevan informaion for invesors of he firm s value creaion capaciy. 19

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