Product market competition, R&D investment choice, and real earnings management

Hsiao-Fen Hsiao, Szu-Lang Liao, Chi-Wei Su and Hao-Chang Sung

International Journal of Accounting & Information Management, 2017, vol. 25, issue 3, 296-312

Abstract: Purpose - Recent studies in the accounting literature have investigated the economic consequences of R&D capitalization. Discretionary R&D capitalization for target beating can be characterized as a firm signaling private information on its future economic benefits or as opportunistic earnings management. R&D capitalization also has an impact on a firm’s marginal costs and product market competition. The purpose of this paper is to address how firms choose R&D levels for the purpose of meeting or beating their earnings targets and how this influences sequential product market competition. Design/methodology/approach - The authors study this issue in a stylized game-theoretic model where R&D choices of a firm are not only strategically made but also used to convey proprietary information to its rival. The model provides a rationale for a firm distorting its R&D level to earn more profits and meet its earnings target. Findings - The equilibrium result indicates that before the realization of common cost shock, a firm can influence the output of its accounting system (i.e. meeting an earnings target) through adjusting its R&D choices. This firm will overinvest in R&D, and this will give an opportunity to create some reserves to be used later to earn a higher profit and reach the earnings target. Originality/value - This paper contributes to the research on real earnings management in terms of how R&D capitalization affects a firm’s R&D choices by influencing the output of its accounting system through adjusting its R&D choices and the strategic impact of those choices.

Keywords: Earnings target; Oligopoly Competition; One-sided incomplete information; R&D investment; Real earnings management (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eme:ijaimp:ijaim-06-2016-0067

DOI: 10.1108/IJAIM-06-2016-0067

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