The Positive Externalities of IFRS R&D Capitalization: Enhanced Voluntary Disclosure

Abstract

Studies comparing IFRS with U.S. GAAP generally focus on differences in the attributes and consequences of the recognized financial items. We, in contrast, focus on voluntary disclosure resulting from arguably the most significant difference between IFRS and GAAP: the capitalization of development costs, the “D” of R&D, required by IFRS but prohibited by GAAP. We document on a sample of Israeli high-technology and science-based firms, some using IFRS and others U.S. GAAP, a significant externality of IFRS development cost capitalization in the form of extensive voluntary disclosure of forward−looking information on product pipeline development and its expected consequences. A disclosure which, we document, is value-relevant to investors beyond the mandated financial information, including the capitalized R&D asset. We also show that the capitalized development costs (an asset) is highly significant in relation to stock prices, and enhances the relevance of the voluntary disclosures. Our results are robust to controlling for self-selection, propensity to disclose voluntarily, and other confounding factors. In the on-going debate about the proper accounting for R&D (the FASB has recently placed an intangibles project on its agenda), such a value-relevant disclosure externality should be of interest to both standard-setters and researchers.