ABSTRACT
This chapter discusses the preferred accounting and reporting for research and development (R&D), by showing empirically that the current accounting for R&D leads to a systematic undervaluation of R&D-intensive companies in capital markets. It investigates whether capitalization and subsequent amortization of R&D expenditures improve the information conveyed by earnings and equity book value about intrinsic equity value. The chapter examines the effect of these R&D adjustments on the association of earnings and book value with current stock price and future pre-R&D earnings, and finds that former association is increased for adjusted earnings and book value numbers. Our results suggest that firms in some but not all industries may improve the informativeness of their financial statements if they capitalize and amortize R&D expenditures over industry-specific useful lives. This suggestion is based on the implicit assumption that increasing the association of reported numbers with intrinsic value is a desirable objective of financial reporting.
