Capitalizing R&D - The Incremental Information Content of Accruals vs. Cash Flows for German Firms

Numerous empirical studies provide evidence on the value relevance of capitalizing expenditures on intangibles such as research & development (Lev and Sougiannis 1996, Hand 2003). However, accounting standards in many countries, such as the U.S. or Germany, prohibit capitalizing these. In this paper, we analyze the role of the capitalization of intangibles in the process of providing value relevant information. Several studies show that accrual information has superior predictive ability compared to cash flows (Wilson 1986, Dechow 1994). Reporting intangible assets on the balance sheet leads to an additional accrual component of earnings which in turn serves as a conveyor of additional information. Within the framework of Dechow (1994) we analyze a sample of the 152 largest German listed companies over a period of five years (2002-2006). Our results show an added value of the accrual information provided by capitalized intangible investments, in accordance with the literature surrounding the idea that accrual information is superior to cash information.