A Model of R&D Capitalization

Gamal Atallah

No 0501E, Working Papers from University of Ottawa, Department of Economics

Abstract: The paper studies the decision of firms to expense or capitalize R&D. In a two-period model, a monopolist decides on how much to invest in R&D and how much of that investment to capitalize, and then on each period's output. It is found that the firm has an incentive to mismatch the benefits and costs of R&D, expensing a larger portion of R&D when the benefits occur mainly in the long run, and capitalizing a larger portion when the benefits occur mainly in the short run. Smaller firms are more likely to expense a larger portion of their R&D expenditures. A faster reaction of markets to the accounting policy reduces expensing. An increase in the discount factor, although having a negative direct effect on expensing, has a net ambiguous effect, because of its effect on R&D. Given that R&D is endogenous to the model, the effects of these changes on innovation and their interactions with expensing are also derived. One major result of the model is that there is strategic substitutability berween R&D and expensing. It is argued that accounting standards, market evaluation of capitalization, and firms' accounting policies can have real effects on innovation. Overall, the model suggests that looser accounting standards, and a less conservative market evaluation of capitalization, can favor innovation.

Keywords: R&D; Innovation; Expensing; Capitalization; Accounting standards (search for similar items in EconPapers)
JEL-codes: L21 M41 O32 (search for similar items in EconPapers)
Pages: ; 14 pages
Date: 2005
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Related works:
Journal Article: A Model of R&D Capitalization (2005)
Working Paper: A model of R&D capitalization (2004)
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