The Accounting Review Vol. 66 No. 1 1991
The Valuation of R&D Firms with R&D Limited Partnerships
Abstract
[This paper investigates whether capital market investors, in assessing market values of R&D firms' equity, view R&D limited partnerships (LPs) as increasing both the assets and liabilities of the R&D firms. The contract terms between the R&D firm and the LP suggest interpreting the LP as a call option held by the R&D firm and using option pricing theory to estimate the asset (the present value of the LP-funded R&D project) and liability (the present value of the exercise price) components of the option. Estimates of the LP variables are derived from information provided in footnote disclosures by R&D firms. However, several important assumptions are necessary to derive these estimates because the footnote disclosures do not provide all the data necessary to calculate the option values. The estimates of the LP variables are included as explanatory variables in a cross-sectional market value regression model that is based on the balance sheet identity. Other variables included in the regression model are the assets, liabilities, and in-house expenditures on R&D reported by the R&D firms in their financial statements. The results are consistent with market participants capitalizing in-house R&D expenditures (though SFAS No. 2 (1974) requires R&D expenditures to be expensed as incurred), viewing the call option feature of the LP as relevant information in assessing the market value of the R&D firm, and utilizing the footnote disclosures to assess the option values. The results support the SEC and the FASB positions that require R&D firms with LPs to disclose to investors the existence of and the amount raised through the LP, but the results do not necessarily support the SEC and FASB positions that this disclosure should be made on the balance sheet. The problems I encountered in estimating the LP variables suggest that more detailed disclosures of the terms of the LP option would help investors to assess the market value of R&D firms. More generally, the results suggest that the FASB should pay particular attention to the types of required disclosures and not be so concerned with whether the disclosures should be on or off-balance sheet in their ongoing consideration of financial instruments and transactions.]
- Volume
- 66
- Issue
- 1
- Pages
- 1-21
- Sources
- bibtex:phds-export.bib