[This article examines whether reported accounting earnings reflect benefits from past research and development (R&D) expenditures and uses the benefits, if any, to estimate the investment value of R&D. The issue is how to extract realized R&D benefits from income statement numbers and is important given the current accounting policy of expensing R&D as incurred. To the extent that market participants can determine realized benefits and expect these benefits to persist in the future, they will use accounting earnings numbers to value current R&D. This study uses cross-sectional data to estimate a recursive system of two equations: one for earnings and one for valuation. The earnings equation associates earnings with recorded assets, advertising, and R&D expenditures. It extracts realized R&D benefits from reported earnings numbers. The valuation equation relates market values of equity to book values, earnings, and R&D expenditures. It determines how the accounting and R&D numbers are valued in the market. The coefficients derived from these two equations are then used to estimate the investment value of R&D. This system of equations assumes that past R&D generates earnings that create market value. The results from the earnings model indicate that reported earnings, adjusted for the expensing of R&D, do reflect realized benefits from R&D. On average, a one-dollar increase in R&D expenditures leads to a two-dollar increase in profit over a seven-year period. The results from the valuation model indicate that investors place a high value on R&D investments. On average, a one-dollar increase in R&D expenditure produces a five-dollar increase in market value. This effect of R&D on market values can be separated into an indirect and a direct component. The indirect effect, when R&D outlays affect market values through earnings, is the capitalized value of R&D benefits reflected in earnings and expected to persist, given that R&D is continuous. In contrast, the direct effect reflects new R&D information conveyed directly by R&D variables. On average, the indirect effect is much larger than the direct effect, implying that R&D information conveyed by earnings numbers is more valued than the information conveyed by the R&D variables themselves. Finally, the study controls for the valuation of R&D tax shields generated when firms expense R&D for tax purposes, and/or qualify for the R&D tax credit. The tax shields are found to be relevant and are valued as earnings.]

[The paper demonstrates empirically that earnings prepared according to Generally Accepted Accounting Principles (GAAP earnings) have properties necessary to serve as a substitute for dividends in equity valuation analysis. Dividends reduce subsequent GAAP earnings, and "intrinsic" equity prices calculated by forecasting earnings are thus reduced by current dividends. This behavior is in accordance with the Miller and Modigliani principle-the displacement property-which states that the payment of dividends reduces prices, dollar for dollar. Further, the paper demonstrates that if this displacement is accommodated in calculating equity prices from forecasted GAAP earnings, those prices exhibit the dividend irrelevance property, that is, calculated prices are insensitive to future dividends. Forecasted GAAP earnings cannot be substituted for dividends, dollar for dollar, but the two are substitutes in the sense that the replacement value of expected dividends reduces forecasted earnings, dollar for dollar.]

Focuses on how to extract realized research and development (R&D) benefits from reported earnings and how to use those benefits in determining R&D investment value. Previous research on R&D valuation; Data and econometric issues; Productivity of corporate R&D; R&D Impact on accounting earnings and market value of equity.

We examine how financial analysts and equity investors incorporate information on deferred taxes from carryforwards into earnings forecasts and share prices. We focus on carryforwards because, in providing this information each period, management must use their private information about the firm's profitability prospects. Thus, accounting measurement of tax carryforwards is another way of providing a management earnings forecast. In analyzing the role of carryforwards in valuation, we distinguish between two conflicting effects. First, deferred taxes from carryforwards represent future tax savings; hence, they should be valued positively as assets. In contrast, the existence of tax carryforwards may signal a higher likelihood of future losses, which would have a negative effect on expected earnings and share prices. We find that analysts consider earnings of firms with carryforwards to be less persistent because of the increased likelihood of future losses. We also find that analysts tend to be less precise and more optimistic (biased) in forecasting earnings of firms with carryforwards. This higher optimism and lower precision are more pronounced just after firms adopt Statement of Financial Accounting Standards (SPAS) 109 and are almost entirely corrected over time. An analysis of investors' valuation indicates a strong positive relation between deferred taxes from carryforwards and share prices, suggesting that these carryforwards are valued as assets. Also, earnings and book values of equity are valued less in firms that have carryforwards than in firms without carryforwards. Finally, the valuation allowance required under SFAS 109 assists equity investors in valuing a firm's earnings and net assets. The combined findings on analysts' interpretation and investors' valuation suggest that analysts fail to fully capture the implication of carryforwards on future earnings within their forecasting horizon.

GAAP mandates the full expensing of R&D in financial statements, presumably because of concerns with the reliability, objectivity, and value-relevance of R&D capitalization. To address these concerns, we estimate the R&D capital of a large sample of public companies and find these estimates to be statistically reliable and economically meaningful. We then adjust the reported earnings and book values of sample firms for the R&D capitalization and find that such adjustments are value-relevant to investors. Finally, we document a significant intertemporal association between firms' R&D capital and subsequent stock returns, suggesting either a systematic mispricing of the shares of R&D-intensive companies, or a compensation for an extra-market risk factor associated with R&D.

Standard formulas for valuing the equity of going concerns require forecasting payoffs to infinity but practical analysis requires that payoffs be forecasted over finite horizons. This truncation inevitably involves often‐troublesome terminal value calculations. This paper contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when each is applied with finite‐horizon forecasts. Valuations based on average ex post payoffs over various horizons, with and without terminal value calculations, are compared with ex ante market prices to discover the error introduced by each technique in truncating the horizon. Valuation errors are lower using accrual earnings techniques rather than cash flow and dividend discounting techniques. The accounting features that make a given technique less than ideal for finite horizon analysis are also detailed. Conditions where a given technique requires particularly long forecasting horizons are identified and the performance of the alternative techniques under those conditions is examined.

We combine a fundamental property of accruals and a behavioral phenomenon to provide an explanation for the accrual anomaly. The fundamental property is accruals that originate must subsequently reverse. The behavioral phenomenon is individuals tend to underestimate the variance of noisy signals in various domains of decision making. We argue that originating accruals represents a noisier signal than reversing accruals because the uncertainty of whether originating accruals will eventually convert into cash is high, while there is no uncertainty regarding reversing accruals. If investors underestimate the variance of originating accruals but understand reversing accruals, then originating accruals will be mispriced while reversing accruals will not. To test this prediction, we first develop and empirically validate a novel method for ex ante detecting accrual originations and their reversals. Then we document that investors face increased uncertainty when accruals originate and decreased uncertainty when accruals reverse, and we provide evidence that only originating accruals are mispriced. We further demonstrate that our findings can be useful for improving the accrual‐based trading strategy by ex ante detecting and removing accrual reversals from extreme accrual portfolios. Overall, we provide a behavioral explanation for the accrual anomaly that is consistent with the mispricing of originating accruals only.

We investigate whether and how the complexity of derivatives influences analysts׳ earnings forecast properties. Using a difference-in-differences design, we find that, relative to a matched control sample of non-users, analysts׳ earnings forecasts for new derivatives users are less accurate and more dispersed after derivatives initiation. These results do not appear to be driven by the economic complexity of derivatives, but rather the financial reporting of such economic complexity. Overall, despite their financial expertise, analysts routinely misjudge the earnings implications of firms׳ derivatives activity. However, we find evidence that a series of derivatives accounting standards has helped analysts improve their forecasts over time.