Review of Quantitative Finance and Accounting, 22: 293–313, 2004
2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Determinants of Investor Valuation of R&D
Expenditure in the Software Industry
C. CATHERINE CHIANG
Assistant Professor of Accounting, School of Business, North Carolina Central University, P.O. Box 19716,
Durham, NC 27707, USA
Professor of Accounting, Rutgers Business School, Rutgers University, New Brunswick, NJ 08854, USA
Abstract. This paper examines the cross-sectional variability in the market valuation of R&D expenditures in
the pre-packaged computer software industry. Consistent with some prior research, this paper argues that R&D
spending is valued heterogeneously by the stock market, and derives hypotheses regarding the determinants of
the cross-sectional heterogeneity in the market valuation of R&D. The empirical tests use an extensive database
containing product level information of software ﬁrms between 1994 and 1998, along with accounting and stock
price data of the same period. The test results, consistent with our hypotheses, show that R&D spending is
more valuable for ﬁrms with larger market shares, higher percentage of technical employees, and those that have
diversiﬁed into different product categories. The results also indicate that market valuation of R&D spending is a
function of product life cycle.
Keywords: R&D, computer software industry, intangible assets valuation
JEL Classiﬁcation: G14, M41
In this paper we explore empirically the value-relevance of research and development
(R&D) accounting in the prepackaged computer software industry. Speciﬁcally, we ask the
following question: Given the ﬁndings of some recent research that the market valuation
of R&D spending is not cross-sectionally constant, what are the key determinants of such
cross-sectional heterogeneity in market valuation?
In recent years, several arguments have been made concerning the shortcomings of the
traditional accounting reporting model in the high technology sector (e.g., Lev and Zarowin,
1999). The conceptual argument against the traditional accounting reporting model is that,
developed as it was for a traditional manufacturing economy, it has severe limitations in
situations where intellectual properties (intangibles) rather than tangible assets predomi-
nantly form the basis of wealth. The argument is bolstered by empirical research. Several
recent studies (Amir and Lev, 1996; Lev and Zarowin, 1999) have found that accounting
This paper is based on the dissertation of the ﬁrst author.