Intangible Assets and Corporate Signaling

Research and development (R&D) and advertising expenditures often result in patents, technologies and brand names which are difficult to accurately value. Under current generally accepted accounting principles (GAAP) these intangible assets are generally not recognized in the financial statements, but instead are expensed in the period that they occur. Prior studies note that the market-to-book ratios of firms with significant levels of R&D and advertising expenditures suggest that investors, at least partially, value these assets. Researchers and practitioners argue that current GAAP, by not recognizing these intangible assets, reduces the usefulness and relevance of accounting reports.We investigate whether companies with significant levels of intangible assets are more likely to emphasize dividend increases and stock repurchases (which are generally perceived as signaling favorable investment opportunities), instead of traditional accounting disclosures, as a means of overcoming adverse selection. Because these assets are difficult to measure, cash distributions may be viewed as a more credible means of signaling firm value to investors. Using analysts' ratings of firms' accounting disclosures, we find that companies with higher levels of R&D and advertising expenditures are less likely to provide extensive accounting disclosures and instead tend to employ dividend and stock repurchase signals. We obtain these results even after controlling for other firm attributes, such as size, stock returns performance, leverage, liquidity and investors' expectations of growth opportunities. We also find that the market reaction to dividend increase and stock repurchase announcements is greater for firms with higher levels of R&D and advertising expenditures, indicating that these announcements are more informative for such firms.     

Accounting choice and future performance: The case of R&D accounting in France

We examine whether managers’ decisions to capitalize or expense R&D expenditures convey information about the future performance of the firm. Focusing on a French setting where managers can choose to capitalize R&D expenditures under certain circumstances, we find that, after controlling for industry effects, firms that capitalize R&D expenditures spend less on R&D, have more volatile R&D efforts, and are smaller and more leveraged than firms that expense R&D expenditures. We also find that capitalizers capitalize R&D outlays when they need to meet or beat thresholds. Finally, we show that the decision to capitalize R&D is generally associated with a negative or neutral impact on future performance, even after controlling for self-selection. Our results also show that when firms both capitalize and expense R&D expenditures, the expensed portion exhibits a stronger (and negative) relationship with future performance. Market-based tests corroborate these findings. While we cannot unambiguously establish whether our findings imply that management uses R&D capitalization to manage earnings or because it is unable to estimate the earning power of R&D projects, our results suggest that management is unable to truthfully convey information about future performance through its decision to capitalize R&D. Our findings, based on real data as opposed to simulated data, therefore contrast with previous supportive evidence in favor of capitalization in the literature.     

Board size and the variability of corporate performance

This study provides empirical evidence that firms with larger boards have lower variability of corporate performance. The results indicate that board size is negatively associated with the variability of monthly stock returns, annual accounting return on assets, Tobin's Q, accounting accruals, extraordinary items, analyst forecast inaccuracy, and R&D spending, the level of R&D expenditures, and the frequency of acquisition and restructuring activities. The results are consistent with the view that it takes more compromises for a larger board to reach consensus, and consequently, decisions of larger boards are less extreme, leading to less variable corporate performance.     

The impact of intangibles on firms’ financial and market performance: UK evidence

This study provides empirical evidence about the effect of intangible assets on firms’ current and future financial and market performance by utilizing a sample the UK FTSE 150 nonfinancial companies. Generally, the findings of this examination reported a strong evidence on the role of intangibles in boosting firms’ performance. In particular, the results indicate that while goodwill (GW) does have a statistically positive effect on firms’ current and future performance, research and development (R&D) is only associated with firms’ future performance. The results of the current research is consistent with the market-based and resources-based theories which posits that intangible investments are the main driving factors of wealth creation in the long-run; Specifically, R&D operations can create new technologies and products that would enhance firms’ performance and value. In addition, the results reveal that both GW and R&D can explain variations in firms’ financial performance measures suggesting that such investments can enhance firms’ earning leading to capitalization such earnings in the market value. Finally, the results of this research provide practical implication for policy makers and managers.     

INTERNATIONAL DIFFERENCES IN RESEARCH AND DEVELOPMENT REPORTING PRACTICES: A FRENCH AND CANADIAN COMPARISON

This paper compares the research and development (R&D) disclosure practices in France and Canada, as evidenced in the annual reports of 76 French and 110 Canadian listed companies. It finds that Canadian high-tech companies (hardware, software, and biotechnology) disclose significantly more information on their R&D activities than their French counterparts. It also finds a strong link between R&D intensity and R&D disclosure among Canadian high-tech companies. Canadian companies overall are also found to be more likely to use non-financial disclosure as a means to resolve any R&D information asymmetry, while French firms disclose more traditional financial and accounting information. Canadian companies are also more willing than French firms to provide information concerning their future R&D expenditures. These results are consistent with inherent cultural and capital market differences between France and Canada. In contrast, the study does not find any significant difference in R&D expenditure capitalization policies between French and Canadian firms.     

Investment policy in family controlled firms

We explore the relation between family ownership and corporate investment policy. Our analysis centers on two incentives, risk aversion and extended investment horizons, which potentially influence the level and type of investments that family firms undertake. We find that family firms devote less capital to long-term investments than firms with diffuse ownership structures. When dividing long-term investment into its two components of R&D and capital expenditures, we note that family firms, relative to nonfamily firms, prefer investing in physical assets relative to riskier R&D projects. Additional tests indicate that family firms receive fewer patent citations per dollar of R&D investment relative to nonfamily firms. Overall, all empirical results indicate that family preferences for lower firm risk, across all family sub-types, affects corporate R&D spending and capital expenditures.     

The value relevance of R&D across profit and loss firms

We examine whether the valuation relevance of R&D documented for loss firms extends to profit firms. We use the residual-income valuation model and show that the valuation multiplier on R&D expenditures is likely to be negative (positive) for profit (loss) firms. This occurs because the linear information dynamics assumption of the residual-income model is more appropriate for profit firms than loss firms. Earnings of profit firms are likely to contain information on the future benefits of R&D activity, however, earnings of loss firms do not contain such information. The empirical evidence confirms our predictions for profit and loss firms. An important implication of our findings is that understanding the role of the R&D expense line item in valuation across firms and within firms, across time depends on whether the linear information dynamics assumption of the residual-income model is applicable for the sample of firms under investigation.     

Shareholder governance, bondholder governance, and managerial risk-taking

We examine the relation between the overall corporate governance structure and managerial risk-taking behavior. We find that the overall governance structure has a significant impact on how managers make decisions on investment policy: strong bondholder governance motivates more low-risk investments such as capital expenditure and lower high-risk investments such as R&D expenditures, whereas weak shareholder governance (entrenched managers) leads to more R&D expenditures. Moreover, we find that the effects of governance on investment policy differ significantly between speculative and investment-grade firms. For speculative firms, strong bondholder or shareholder governance leads to more capital expenditures and low R&D investments. For investment-grade firms, strong bondholder or shareholder governance leads to low capital expenditures and an insignificant impact on R&D investments. Furthermore, financing and investment covenants exhibit strong binding power to deter risky investments. Finally, a more dependent (or a less independent) board is associated with low capital expenditures and high R&D investments.     

Industry expertise on corporate boards

Recent surveys indicate that industry expertise is the most sought-after director qualification. Yet evidence on the value of such expertise is limited. This paper shows that firms that are difficult for non-experts to monitor and advise are more likely to appoint industry expert directors. Such appointments also depend on the supply of industry-experienced candidates in the local director labor market. Board industry expertise reduces R&D-based real earnings management and increases R&D investments. The increase in R&D spending is value-enhancing: firms with industry expert directors receive more patents for the same level of R&D, their R&D spending is associated with lower volatility of future earnings, and their value is higher. Finally, industry expertise is associated with CEO termination and pay incentives that encourage R&D investments.     

Corporate valuation around the world: The effects of governance,growth, and openness

The purpose of this paper is to provide a comprehensive analysis of corporate valuation around the world. Specifically, we (i) document and compare corporate valuation around the world, and (ii) identify the key factors that drive cross-country differences in valuation. In doing so, we utilize the country-level Tobin’s q (CTQ), computed as the ratio of the aggregate market value to book value of all assets held by all public firms domiciled in a country, which amounts to the Tobin’s q for the ‘market portfolio’ of the country. The key findings of the paper are: First, CTQ varies greatly across countries, ranging from 0.73 for Venezuela to 2.11 for Finland, with the international mean of 1.30 during our sample period 1999–2004. Despite the steady integration of the world economy in recent years, corporate valuation remains starkly different across countries. Second, apart from the effect of corporate governance, cross-country differences in corporate valuation are significantly driven by the growth options of countries represented by the R&D intensities, capital expenditures, and GDP growth. In addition, the degree of capital market openness has a significant, independent effect on valuation. Third, our regression analyses show that CTQ varies directly with shareholder rights, enforcement of insider trading laws, GDP growth, R&D intensity, and the degree of capital market openness. The key findings remain robust to the inclusion of inflation and industry effects.     

Equity compensation and the sensitivity of research and development to financial market frictions

When financial market frictions exist, executives may have to decide which investment activities to reduce when internal funds decrease. Expenditures on research and development (R&D) may be particularly vulnerable because of the long-term nature of innovative activity. We find that equity compensation is associated with lower levels of firm R&D expenditures. Rewarding executives to incur more risk has little effect on R&D expenditures, but rewarding executives for higher returns reduces R&D expenditures and makes R&D expenditures more sensitive to financial market frictions. In contrast, cash compensation reduces the sensitivity of R&D expenditures to financial market frictions.     

R&D productivity following first-time CIO appointments

Prior studies find that firms announcing the appointment of a new chief information officer (CIO) are rewarded by stock price increases, suggesting that the market expects new CIOs to add longterm value to the firm. In this paper, we examine whether first-time CIO appointments result in improved R&D productivity. We focus on R&D investments because one role of IT management is to aid in discovery and management of growth opportunities. Successful R&D activities are designed to create the type of knowledge-based, growth-critical assets (new or improved products, better distribution methods, etc.) that effective IT management would be expected to assist. After controlling for industry performance, we find that the productivity of R&D improves significantly after the appointment of a new CIO for appointments before 1999 (1997–1998) but not for appointments in later years (1999–2007), and that productivity improvements over the entire sample period occur for CIO appointments by firms with superior IT capabilities. Our results for R&D investments suggest that new CIOs improve the way IT is managed and improve their firms' approach to knowledge management.     

Real Options, Product Market Competition, and Asset Returns

We study how competition in the product market affects the link between firms' real investment decisions and their asset return dynamics. In our model, assets in place and growth options have different sensitivities to market wide uncertainty. The strategic behavior of market participants influences the relative importance of these components of firm value. We show that the relationship between the degree of competition and assets' expected rates of return varies with product market demand. When demand is low, firms in more competitive industries earn higher returns, whereas when demand is high firms in more concentrated industries earn higher returns.     

Vertical merger,R&D collaboration and innovation

This paper studies the effects of vertical merger and R&D collaboration activities on firms' innovation decisions and stock returns based on a continuous-time real option model under market and technological uncertainties. Our analysis confirms vertical merger's benefit in amplifying the potential gain from innovation through eliminating inefficiencies. We show that vertical merger boosts innovation incentives in two ways: it reduces the optimal innovation threshold when firms suspend the project and increases R&D investment when firms launch the project. If vertical merger is not possible, R&D collaboration can improve firms' innovation levels as an alternative decision, but inefficiencies still exist which implies less pronounced stimulation effects. Both vertical merger and R&D collaboration can reduce firms' risk when conducting innovation project and weaken the positive R&D-returns relation and financial constraints-returns relation, while these effects of vertical merger are stronger than those of R&D collaboration.     

Corporate investment and changes in GAAP

This paper investigates whether changes in Generally Accepted Accounting Principles (GAAP) affect corporate investment decisions. Using a sample containing forty nine changes in GAAP, I find that changes in accounting rules affect investment decisions. I then examine two mechanisms through which changes in GAAP affect investment. First, I find that changes in GAAP affect investment, particularly R&D expenditures, when firms have financial covenants that are affected by changes in GAAP. Second, I find evidence suggesting that the process of complying with some changes in GAAP alters managers’ information sets and consequently changes their investment decisions, particularly their capital and R&D expenditures and, to a weaker extent, their acquistion expenditures. This paper contributes to the literature on the real effects of accounting by providing evidence that accounting rules affect investment decisions even when the rule change does not concern the measurement and reporting of investment, and by documenting specific mechanisms through which the relation manifests.     

The size,concentration and evolution of corporate R&D spending in U.S. firms from 1976 to 2010: Evidence and implications

The use of research and development (R&D) spending as an empirical proxy for managerial discretion, information asymmetry and growth opportunities, is pervasive in empirical corporate finance research. Underlying this is the implicit assumption that firms choose levels of R&D to maximize value, given firm and industry characteristics. An alternative framework views the level of R&D spending as subject to idiosyncratic behavior as managers myopically manipulate R&D expenditures to meet short-term earnings goals. Using aggregate firm and industry level data, we find evidence consistent with the view that R&D is determined by firm and industry characteristics. Time invariant firm and industry fixed effects explain most of the cross-sectional variation in observed R&D spending, while time-varying factors like size, profitability, or market-to-book explain little of the cross-sectional variation. We find that R&D spending continues to grow faster than advertising and capital expenditures. We also find no evidence of managerial myopia as corporate aggregate R&D expenditures are growing faster than aggregate profitability and the number of firms that undertake R&D has increased over the period from 1976 to 2010.     

Uncertainty and R&D investment: Does product market competition matter?

In recent years, the question of how uncertainty influences corporate decisions has received greater interest among academics, researchers, and corporations. This study is an attempt to investigate how uncertainties (firm-specific uncertainty (fsu), market-based uncertainty (mu), and economic policy uncertainty (epu)) influence research and development (R&D) investment and to further examine whether this relation is moderated by product market competition across firms of different sizes. Using a sample of Chinese listed firms covering 2000–2017, this study applies a two-step system GMM model to perform estimations and control for endogeneity issues. The findings show that uncertainties (fsu, mu, and epu) negatively influence R&D investment and that this negative relationship is more prominent for firms operating in competitive industries. In concentrated industries, however, the negative impact of uncertainty is mitigated for large firms, which have more internal resources and better access to external financing. This study contributes to real options theory by illustrating how different forms of uncertainty embedded in a firm’s internal and external environment reduce R&D investment, and by indicating how this relationship is moderated by product market competition.     

Intangible Assets and Firms' Disclosures: An Empirical Investigation

This study examines how research and development (R&38;D) and advertising expenditures affect firms' disclosures. Generally accepted accounting principles (GAAP) mandate that these expenditures be immediately expensed in financial reports, despite the fact that they often benefit the firm for longer periods. Prior studies find, however, that investors consider intangible assets in their valuation of firms. These studies argue that current GAAP, by not recognizing the value generated by these assets, severely impairs the usefulness of accounting reports. I investigate if firms with higher levels of R&38;D and advertising expenditures place greater reliance on voluntary, and therefore more flexible, disclosures such as voluntary publications and investor relations. Using analysts' ratings of firms' disclosures, I find that firms with higher levels of intangible assets are more likely to receive significantly higher ratings for their investor relations programs or voluntary publications than for their annual reports. These findings suggest that firms with higher levels of intangible assets emphasize supplemental disclosures because mandated accounting disclosures inadequately present their financial performance. These results have important policy implications for regulators and investors since they indicate that voluntary disclosures, which are unregulated and unaudited, are an important means of disclosure for these firms.     

How Do Financing Constraints Affect Firms’ Equity Volatility?

Theory suggests that financing frictions can have significant implications for equity volatility by shaping firms’ exposure to economic risks. This paper provides evidence that an important determinant of higher equity volatility among research and development (R&D)‐intensive firms is fewer financing constraints on firms’ ability to access growth options. I provide evidence for this effect by studying how persistent shocks to the value of firms’ tangible assets (real estate) affect their subsequent equity volatility. The analysis addresses concerns about the identification of these balance sheet effects and shows that these effects are consistent with broader patterns on the equity volatility of R&D‐intensive firms.     

International Financial Reporting Standards and the value relevance of R&D expenditures: Pre and post IFRS analysis

This study examines the value relevance of research and development (R&D) expenditures in the pre and post International Financial Reporting Standards (IFRS) periods in the UK. It also examines firm size and sector-based differences in the value relevance of R&D during the sample period between 2001 and 2011. The results indicate that capitalized R&D has value relevance during the 11 years sample period. However, the value relevance of capitalized R&D does not appear to have improved in the post-IFRS period. Large firms present higher value relevance of capitalized R&D than small firms which suggest that firm size has significantly different valuation effects on the value relevance of R&D expenditures. Sectors, however, do not appear to present valuation differences across manufacturing and nonmanufacturing firms. The overall findings of this study report no difference in the value relevance of expensed R&D in the pre and post-IFRS periods; however, the value relevance of capitalized R&D appears to decrease from pre to post-IFRS period. We thus argue that these findings have implications for the regulators and accounting professionals.