Value relevance of R&D reporting: a signalling interpretation

Cahier de Recherche du CEREG, Université Paris-Dauphine, n° 2003-12Accounting for research and development (R&D) costs is an open issue. SFAS N°2 mandates that all R&D costs are immediately expensed. International standards prescribe a capitalization of R&D costs if they meet certain criteria (IAS 38). Recent research papers (Healy et al., 2002; Lev and Sougiannis, 1996, 1999; Aboody and Lev, 1998, Zhao, 2002) show that capitalization of R&D costs and software development costs is value relevant. However critics can be leveled at previous research because prior empirical tests are based on simulated or partial data. Our purpose is to test empirically R&D accounting issues on a sample of 95 French firms on a three years period (1998-2000). French context provides an experimental field for studying the value relevance of R&D capitalization, because both accounting treatments of R&D costs (expensing and capitalization) are allowed. We find that capitalized R&D is positively associated with stock returns and stock prices, whereas expensed R&D is negatively related to stock prices and stock returns. R&D accounting reduces the information asymmetry on the successfulness of R&D projects: it acts as a signal to investors. This paper extends previous literature by using real data on capitalized R&D, instead of estimated data. Moreover, we show not only that capitalized R&D is value relevant but also that expensing of R&D projects conveys a negative signal