This paper discusses Monahan’s empirical study of how conservative accounting of R&D affects the relations (i) between earnings and stock return; (ii) between estimates of value using the residual income valuation model and equity market value. My discussion focuses on the underlying mechanism of why growth matters and how the growth rate should be measured. In particular, I argue that different aspects of growth (e.g., short-term growth versus long-term growth) matter under different circumstances, depending on the intended use of accounting data. Failure to adjust for these differences affects the effectiveness of the empirical tests. The discussion also considers the impacts of potential noise in the R&D capitalization procedure and the presence of other intangible assets.
Review of Accounting Studies – Springer Journals
Published: Apr 23, 2005
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