R&D expenditure and earnings targets

R&D expenditure and earnings targets
Document type
Working Paper
Author(s)
Osma, Beatriz Garcia; Young, Steven
Publisher
Manchester Business School
Date of publication
1 January 2006
Series
University of Manchester Business School Working Papers. No. 514
Subject(s)
Trends: economic, social and technology trends affecting business
Collection
Business and management
Material type
Reports

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This paper examines whether firms cut R&D spending in response to short-term earnings pressures and how the market evaluates such behaviour. Failure to beat an earnings benchmark increases the probability that R&D spending is pruned in the following period, while pressure to achieve current-period targets leads to contemporaneous cuts in R&D investment. The strength of the contemporaneous link between R&D manipulation and benchmark beating behaviour increased following the introduction of Financial Reporting Standard No.3: Reporting Financial Performance in 1993, suggesting substitution of classificatory earnings management with real operating manipulation. While on average investors discount earnings increases accompanied by unexpected cuts in R&D spending, their response depends on the perceived reason for the cut and the importance of R&D investment as a driver of firm value.

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