Three Studies on Corporate Reporting and Disclosure of Research and Development

Abstract

This thesis examines the factors that affect the financial reporting and corporate disclosure of research and development (R&D). Due to the significance of R&D in determining firm value as well as the proprietary costs that restrict management transparency, there is a high level of investor demand for R&D-related information. In deciding how and what they might disclose about the firm's R&D activities, managers can choose between two potential channels of disclosure to investors. These are capitalising R&D expenditures and making additional narrative disclosures regarding R&D (Dinh et al. 2020). To study these two channels, I examine the management financial reporting choice to capitalise R&D in countries that adopt the International Financial Reporting Standards (IFRS) (Study I), and the R&D narrative disclosures using US 10-K filings (Study II and Study III). In Study I, I examine the effect of country-level accounting and auditing enforcement on the informativeness of R&D capitalisation in 19 countries that have adopted IFRS as of 2005 (hereafter "IFRS countries"). I find that the market valuation of capitalised R&D is lower in countries with stronger enforcement, suggesting that the market places less value on R&D capitalisation when managers are more constrained in their ability to signal information through capitalisation. I also find that capitalised R&D has a stronger positive association with future earnings in strong-enforcement countries compared to weak-enforcement countries, indicating that strong enforcement is associated with R&D capitalisation of higher quality. In Study II, I investigate the association between R&D ability and R&D narrative disclosure quantity. While R&D disclosure provides critical information to the market, it can impose significant proprietary costs on the disclosing firms as a consequence of imitation and competition from rivals. Hence, firms with strong ability may withhold R&D information to defend their competitive positions in the market. Therefore, I hypothesise that R&D ability is negatively associated with the quantity of R&D narrative disclosure. Using content analyses of 10-Ks of US listed firms, I find evidence consistent with this hypothesis. In the cross section, I find that the negative relationship between R&D ability and the level of R&D narrative disclosure is only prevalent when proprietary costs are high. Last, I find that firms substitute R&D-specific disclosures with general (i.e., non-R&D-specific) innovation and forward-looking disclosures to convey messages without revealing actionable information. In Study III, I extend Study II to consider the impact of Chief Executive Officer (CEO) risk incentives on the readability of R&D narrative disclosure. Extant literature has found that CEO vega (i.e., the sensitivity of CEO wealth to firm risks) is associated with risk-taking that reduces firm value (e.g., Dong, Wang & Xie 2010; Sanders & Hambrick 2007). Consequently, CEOs may obfuscate the disclosure of their risk-taking behaviour. Using R&D as the risk-taking setting, I find that CEO vega is associated with less transparent R&D disclosure. In subsample analyses, I find that this effect is less prevalent when managerial opportunistic incentives are weaker, suggesting that information obfuscation motives at least partially explain the association between CEO vega and R&D disclosure quality.