The Role of External Monitoring in Firm Valuation: The Case of R&D Capitalization

We investigate whether the use of a high quality auditor and increased regulatory monitoring of R&D reporting influence both the level of R&D expenditure capitalized by Australian companies from 1992 to 2002 and the market’s perception of the reliability of these figures. The results indicate that firms with a higher quality auditor capitalize lower levels of R&D costs and that in the period following increased regulatory monitoring, firms capitalize fewer R&D costs. Analysis of the value relevance of R&D expenditure indicates that the market positively values R&D costs when expensed as incurred. These results are consistent using both price and returns models. Results are less persistent for capitalized R&D amounts. The finding from the returns model indicates that the quality of the auditor appears to enhance the reliability of capitalized R&D costs while the price model suggests that the cumulative R&D asset is less relevant in the period following ASC monitoring.