Pantea Alirezazadeh UNIVERSITY OF CONNECTICUT Communicating the Value of Intangibles: The Role of Capitalization and Patent in the Software Industry
Dec 22, 2015
Pantea AlirezazadehU N I V ER S ITY O F C O N N EC TIC U T
Communicating the Value of Intangibles: The Role of Capitalization and Patent in the
Software Industry
Research Objective
In the case of R&D assets of software development companies, do firms with large number of filed patents capitalize more of their software development cost?
Does filing for patent reduce the information asymmetry between the market and the firm?
How both filled patents and capitalized software development cost interact and what would be their mutual effect on information asymmetry?
Outline
IntangiblesAccounting Rules for Capitalization of R&D AssetsFilling for PatentPrior researchHypothesis DataResult
IntangiblesAccounting rules define an asset intangible if it owns the
following characteristics:
Lack of physical substanceNon-financial natureInitial useful life extends beyond a single financial
reporting period
How it measure Intangibles?
Market Capitalization
Return on Invested Capital
Score Cards
Direct Measure of Intellectual Capital
Brand Valuation
Research and Development
The Standard of Financial Accounting Standards(SAFS) No. 2 requires the immediate expensing of all R&D activities.
SFAS No. 86 indicate that software capitalization, the only exception in the United States to the full expensing rule of R&D (SFAS No. 2), can be capitalized under certain conditions
SFAS No. 86 Requirements
InitiationStage
Technical Feasibility Ready to be Sold
Software Sale
Expense Capitalize Capitalize Expense
Capitalized Software Development Costs
Income Statement
Operating Expenses: Depreciation/Amortization R&D
Balance Sheet
Assets: Property, Plant, Equipment Capitalized Development Cost
Prior Literature: Capitalize or Expense!?
Capitalizing software developments costs leads to higher earnings variability which is positively correlated with forecast errors (Shi 2002).
Analysts concerned with the size of their earnings forecast errors view capitalization negatively (Aboody and Lev 1998).
The greater the uncertainty of future economic benefits from R&D expenditures, the weaker would be the case in favor of capitalization (Kothari and et. al 2002).
Prior Literature: Capitalize or Expense!?
Capitalized values of R&D are significantly associated with stock prices. (Lev and Sougiannis 1996)
Capitalization-related variables in the financial statement are significantly associated with capital market variables and future earnings. (Aboody and Lev 1998)
The expensing of R&D by firms with increasing investment rate in R&D is associated with a decline in the informativeness of reported earnings. (Lev and Zarowin 1999)
Capitalization of intangibles is associated with higher analyst following and lower absolute earnings forecast errors. (Matolcsy and Wyatt 2006)
Allowing managers to credibly signal their superior information by either capitalizing successful R&D investment or expensing unsuccessful R&D investments reduces information asymmetry. (Ahmed and Falk 2006).
Patents: A Popular Choice of Innovation Proxy
Patentable
Patentable Subject Matter
Industrial Application
New
Non-Obvious
Prior Literature: Patenting and Market Value
Patent citation has a noticeable effect on market value (Hall and et. al. 2005).
Patents have a significant impact on firm-level productivity and market value (Bloom and Reenen 2002).
There is positive relation between the future operating performance and productivity of a firms’ innovation efforts (Pandit et. al. 2009 ).
Hypothesis
Hypothesis I: The amount of capitalized software development cost is significantly higher for the firms that have filed more patents.
Hypothesis II: Filing for patent reduces the information asymmetry.
Hypothesis III: The presence of successfully issued patents moderates the signaling power of capitalized software development cost.
Variable DescriptionCapValue Capitalized software development cost divided by market value
MarketValue Market value of the firm three months after the fiscal year
DevelopmentIntensity Annual software development costs to sales
Profitability Net income plus software amortization minus the annually capitalized software divided by sales.
Leverage Long-term debt divided by book value of equity
Patent The number of patents applied by the end of the fiscal year
Spread Annual average of the logarithm daily relative bid-ask spread, defined as absolute value of the bid-ask spread divided by their average
Volatility Logarithm standard deviation of daily stock return
Capitalization The amount of capitalized software development cost
Patent Dummy 1 if the firm has filed any patent that year and 0 otherwise
Turnover Annual average of logarithm trading volume in shares divided by number of shares outstanding
Price Annual average of the logarithm of daily stock price
Analyst Number of analysts supplying one-year ahead earning forecast
Data
COMPUSTAT, CRSP, I/B/E/S
SEC Filings,
DirectEdgar
USPTO,
NBER
260 firms for years 2000 to 2008 Computer programming and
prepackaged companies: SIC 7370-7372
Data Collection:
Capitalization of the software development cost and amortization of software asset
Financial data Patent Data
Hypothesis I
itititit
itY
ititYit
ntLogLagPateeLogLeveragyofitabilitLog
itymentIntensLogDevelopalueLogMarketVYReLogCapValu
1643
2008
2000210
Pr
Variable Coefficient t-value
LogMarketValue -.0079 -5.75***
LogDevelopmentIntensity .0063 2.88***LogProfitability .0076 4.2***LogLeverage .0035 4.64***LogLagPatent .0030 2.75***
***Denote significance at a probability level below 0.01**Denote significance at a probability level below 0.1
Heckman Model
itititit
itY
ititYit
ntLogLagPateeLogLeveragyofitabilitLog
itymentIntensLogDevelopalueLogMarketVYReLogCapValu
1643
2008
2000210
Pr
Variable Coefficient t-value
LogMarketValue -.0079 -5.40***
LogDevelopmentIntensity .0063 2.88***LogProfitability .0076 4.2***LogLeverage .0035 4.64***LogLagPatent .0030 2.75***
***Denote significance at a probability level below 0.01**Denote significance at a probability level below 0.1
Hypothesis II
variable Coefficient t-value
LogMarketValue -0.19 -13.75 ***
Volatility 0.37 11.00 ***
Turnover -0.42 -31.76 ***
Price -0.31 -17.08 ***
Analyst -0.002 -1.53
Patent -0.02 -1.81**
ititit
itititY
ititYit
iedPatentApplAnalyst
iceTurnoverVolatilityetValueLogLogMarkYRSpread
76
43
2008
2000210 Pr
***Denote significance at a probability level below 0.01**Denote significance at a probability level below 0.1
Hypothesis III
Variable Coefficient t-Value
LogMarketValue -0.20 -15.92***Volatility 0.39 11.53***Turnover -0.41 -33.08***Price -0.3 -17.86***Analyst -0.002 -1.61PatentDummy -0.06 -3.3 ***Capitalization -0.008 -0.93PatentDummy*Capitalization 0.10 4.05***
itititit
ititY
itititYit
ationyCapitalizPatentDummtionCapitalizayPatentDummAnalyst
iceTurnoverVolatilityalueLogMarketVYRSpread
8765
4
2008
20003210 Pr
***Denote significance at a probability level below 0.01
Hypothesis III
Variable Coefficient t-Value
SharOut 0.12 3.73***Analyst 0.0035 9.72***PatentDummy 0.34 6.01***Capitalization 0.01 0.37PatentDummy*Capitalization -0.08 -1.84**
***Denote significance at a probability level below 0.01**Denote significance at a probability level below 0.1
itit
itititY
ititYit
ationyCapitalizPatentDummtionCapitaliza
yPatentDummAnalystSharOutSharOutYRTurnover
65
432
2008
200010
Conclusion
Both filing for patent and capitalizing the software development costs both reduce the information asymmetry between firm and the market.
Firms that file for more patents have a higher rate of capitalization.
Filing for patent reduces the effect of capitalization on information asymmetry.