R & D Accounting Reform To Improve The Usefulness Of Accounting Information? Th

From 2007 onward, R&D spending of Chinese listed firms is no longer required to be expensed immediately. Meeting certain criteria, some R&D spending can be recognized as capital. This study examines whether this reform enhances the usefulness of accounting information for those firms affected. More specifically, to investigate the valuation role of accounting information, I focus on value relevance and analyst coverage; to investigate the contracting role of it, I focus on the executives pay-performance sensitivity and the CEO’s turnover-performance sensitivity.Theoretically speaking, the R&D accounting influences the the tradeoff between relevance and reliability of accounting information, a perpetual debate related to accounting standards setting. Mandating immediate spensing reduces the relevance of accounting information, because managers could have communicated with financial information users by signaling their belief and insider information on R&D projects. However, by doing so, managers are believed to provide more reliable information, because conditional capitalization provides room for managers to manipulate earnings by discretionary capitalization, amortization and writing off. In a word, for the R&D accounting reform from unconditional expensing to conditional capitalization, the tradeoff between the increase of relevance and decrease of reliability decides the change of usefulness.We find that after the reform went into effect in year 2007, comparing with those firms unaffected by the reform, those affected firms witness enhancement of both valuation and contracting roles of accounting information. To be specific, benchmarking on those firms unaffected by the reform, we find that those affected firms are associated with increased value relevance of both book value in balance sheet and earnings in income statement, increased analyst coverage, improved executive pay-performance sensitivity and improved CEO turnover-performance sensitivity.To provide wider understanding to the economic consequence of R&D accounting reform, I go one step further to examine the cross-sectional variation of the influence of the reform on accounting information usefulness. More specifically, I compare such influence on the firms with higher accounting quality and firms with lower accounting quality. Either sample may benefit more from the reform. On the one hand, firms with higher accounting quality may better off because its increase of relevance will dominate the decrease of reliability; on the other hand, firms with low accounting quality may benefit more because those firms have more marginal benefits when a new communication channel is opened (R&D capitalization). Finally, the empirical results show that those firms with lower accounting quality benefit from the reform more than their peers with higher accounting quality and this conclusion holds for all four different tests, including value relevance, analyst coverage, executive pay-performance sensitivity and CEO turnover-performance sensitivity. I use two different measurements of accounting quality, including the standard deviation of discretionary accounting derived from Modified DD model (Francis et al.,2005) and the asymmetry timeliness in recognition of good news and bad news (Basu 1997), and get consistent results.This study can contribute to our understanding on Chinese IFRS convergence, especially on the reform of accounting treatment on R&D spending. Moreover, this study has the potential to contribute to international literature. In the U.S., SFAS No. 2 (1974) requires that all R&D spending be expensed immediately (Daley and Vigeland,1983; Elliott,1984; Selto and Clouse,1985); SFAS No.86 (1985) provides an exception to the GAAP requirement of immediate expensing, a reform that has motivated numerous studies in accounting (e.g., Lev and Sougiannis,1996; Aboody and Lev,1998; Healy et al.,2002; Kothari et al.,2002). More than 20 years later, scholars’enthusiasm is still not on the wane (Lev et al.,2005; Mohd,2005; Seybert, 2010). What’s more, given the belief that the U.S. is on the track of converging to IFRS, we can reasonably anticipate that accounting scholars will pay more attention to the issue of R&D capitalization in the future.