The immediate expensing of research and development (R&D) expenditures is often justified by the conservatism principle. However, no accounting procedure consistently applied can be conservative throughout the firm's life. We therefore ask the following questions: (1) When is the expensing of R&D conservative and when is it aggressive, relative to R&D capitaliza‐tion? (2) What are the capital‐market implications of these reporting biases? To address these questions we construct a model of profitability biases (differences between reported profitability under R&D expensing and capitalization) and show that the key drivers of the reporting biases are the differences between R&D growth and earnings growth (momentum), and between R&D growth and return on equity (ROE). Companies with a high R&D growth rate relative to their profitability (typically early life‐cycle companies) report conservatively, while firms with a low R&D growth rate (mature companies) tend to report aggressively under current generally accepted accounting principles. Our empirical analysis, covering the period 1972‐2003, generally supports the analytical predictions. In the valuation analysis we find evidence consistent with investor fixation on the reported profitability measures: we detect undervaluation of conservatively reporting firms and overvaluation of aggressively reporting firms. These misvaluations appear to be corrected when the reporting biases reverse from conservative to aggressive and vice versa. This evidence is consistent with behavioral finance arguments about investor cognitive biases.

We select a small set of recommendations that lie in the upper and lower tail of the empirical distribution of divergences between a recommendation, and the consensus over the window (−30, −1) days prior to that recommendation. We classify these extremely divergent recommendations as bold, and then subdivide them into informative bold recommendations that lead other analysts (leading‐bold) and those that are ignored by other analysts (contra‐bold) based on the consensus change in the 30 days after the announcement. We focus on the information conveyed to the market by these bold, leading‐bold, and contra‐bold recommendations through their effects on cumulative abnormal returns (CAR). We find that bold recommendations are not anticipated by market participants (CARs are negative before a bold buy and positive before a bold sell). The next finding is that the market responds strongly to both leading and contra‐bold recommendations over the (0, +4)‐day window and that these reactions are stronger than that to nonbold recommendations. In contrast, over the longer (0, +30)‐day window, leading‐bold recommendations earn additional returns whereas contra‐bold ones reverse significantly due to lack of confirmation. The overall pattern is one of rational market reaction both in the short and long windows. We support the rationality of the market reaction by showing that the percentage of leading‐bold recommendations exceeds that of contra‐bold recommendations, and that these two types of recommendations cannot be separated using observable analyst characteristics such as experience or brokerage size.