The Impact of R&D Expenditures on Earnings Management

The main goal of the paper is to investigate the relationship between R&D spending and earnings management. While R&D expenditures create some of the most precious assets in today’s economy, in many accounting jurisdictions they either may not be recognised as an asset in the balance sheet or their recognition is very limited. The main obstacle is the measurement process’s lack of reliability, which is the result of information asymmetry caused by the nature of R&D investments. Additionally technological breakthroughs do not necessarily translate into commercial success. The results of studies conducted until now provide evidence that managers taking responsibility for high-cost R&D projects become more and more emotionally engaged as time passes. In this paper, it is theorised that this phenomenon is also an important factor in earnings management. The following hypothesis is put forward: R&D expenditures are a significant determinant of earnings management after a two-year time lag. The time lag is adopted on the basis of the average length of time a research project lasts. The empirical study was done on the basis of a sample of US stock listed companies (more than 4,500 firm-year observations). The group was chosen because US GAAPs require all R&D costs (with a few exceptions) to be fully expensed. This enables one to easily determine R&D spending, which would not be possible in the case of companies reporting under IFRSs. Regression analysis shows that R&D spending is a statistically significant determinant of earnings management after two and three time lags. The hypothesis was verified, suggesting that R&D  investments influence managerial behaviour with regard to earnings management.