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Reporting Distortions and Inefficient Managerial Resource Allocation: In Intangible-Intensive Firms

Yoshie Saito Lord, Eastern Illinois University

ABSTRACT: The immediate expensing of R&D costs distorts accounting information, ignoring the future benefits arising from these expenditures. However, this treatment is justified because the values of intangible investments are difficult to verify. I focus on how this conservative treatment of intangibles affects managerial resource allocation decisions and analyze the consequences of conservatism on ROA for intangible-intensive firms. I employ a stochastic frontier estimation technique and find that conservatism is associated with shortfalls in ROA. This adverse effect of accounting conservatism is magnified when managers have stronger incentives to offset some of the expected decline in current earnings. For firms with positive earnings, managers are more likely to reduce R&D spending if they expect current earnings to decline. But, if firms have negative earnings, managers are less likely to reduce R&D spending even when they expect current earnings to decline.

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