There are two main ways of presenting intangible assets in corporate reports: capitalisation and disclosure. However, the financial information is affected only by capitalisation. As such, markets may react differently for capitalisation compared to disclosure.
The value relevance of software capitalisation was examined by Aboody and Lev (1998) who noted that both the annual software capitalisation amount and the cumulative software assets are positively and significantly associated to stock returns and prices. Also, the results indicated that the capitalisation change variable is associated with subsequent earnings changes.
Barth and Clinch (1998) investigated whether relevance, reliability and timeliness of Australian asset revaluations differ across type of assets, including investments; property, plant and equipment; and intangibles. Also the study investigated whether relevance, reliability and timeliness differ if the valuation amount is determined by the firm‟s board of directors or an independent appraiser, for more versus less timely valuations, and for revalued amounts that are above or below historical cost. Results reported that revalued investments are consistently significantly associated with share prices, except for investments of non-financial firms in the associated companies. The study also found that revalued intangible assets are consistently, significantly and positively associated with share prices, contradicting the view that such estimates are
unreliable. Further, the results reported the revalued aggregate PPE is significantly positively associated with share prices for firms in all three industries.
Taken together, their findings suggest revalued financial, tangible, and intangible assets are value relevant in an Australian market. Although the financial assets findings are not surprising based on prior research, the intangible assets findings are striking in their strength and consistency. Findings for PPE are less consistent, although the stronger value relevance for plant and equipment than for property suggests revalued operating assets are more value relevant than assets less directly related to operations. Further, there is little evidence to indicate that director and independent appraiser-based valuations are viewed differently by investors, suggesting directors‟ private information enhances value estimates despite their potential self-interested financial statement management incentives. Finally, the evidence suggests that both upward and downward revaluations are value relevant, although the discretionary nature of asset write-ups through earnings can affect their value relevance.
Espahbodi et al. (2002) tested the equity price reaction to the pronouncements related to accounting for stock-based compensation, which assessed the value relevance of recognition versus disclosure in financial reporting. Results indicated that firms exhibited abnormal returns around the issuance of the ED proposing to require recognition of stock-based compensation (SBC) costs, and also around the event reversing that decision to require disclosure only (while encouraging recognition). Results showed that the abnormal returns are most pronounced for high-tech, high- growth and start-up firms. The study also documented that the stock price impact is positively related to the existence of tax loss carry-forward, the extent of stock option
usage (as reflected by its effect on EPS), and retained-earnings related debt constraint; and negatively related to the noise in stock price performance, free cash flow over total assets and firm size.
The significance of abnormal returns around the event reversing the decision to require only disclosure is consistent with the contracting theory, and shows that market participants value disclosure and recognition differently (or that disclosure is not a substitute for recognition). Requiring companies to disclose only the cost of SBC rather than forcing recognition as was proposed earlier would involve no new information and should not affect security prices, except through the contracting and political cost hypotheses (as future earnings will be affected by recognition, but not by disclosure of SBC costs).
The value relevance of R&D and advertising expenditure of Korean firms was examined by Han and Manry (2004). They commented that the market may accept the information about R&D whether it was capitalised or expensed. Despite this, disclosure is important for value creation. Similarly, Godfrey and Koh (2001) provided evidence that capitalisation of intangible assets, as a whole provides information that is relevant for firm valuation in Australia. Further, they reported that the information is relevant over and above the information provided by other balance sheet items.
Kallapur and Kwan (2004) added to the literature by examining the relevance and reliability of brands recognised on the balance sheet of 33 UK firms beginning in 1995. Brand assets measurement in this sample was subject to managerial discretion, the sample firms acquired brands not in isolation but as part of business acquisitions, and
valued them separately from goodwill. The study found that brand assets are value relevant. However, the market capitalisation rates of brands of firms with low contracting incentives are higher than those of firms with high contracting incentives to capitalise and overstate brand values.
Findings suggest that managers‟ discretionary valuation of intangible assets recognised in financial statements might not be reliable. However, given the differences in market capitalisation rate, the markets do seem capable of seeing through differences in reliability. Kallapur and Kwan‟s (2004) findings, therefore, do not suggest that markets are misled by lack of reliability. Their study contributes not only to the literature on value relevance and reliability of intangible assets, and more generally of recognised discretionary amounts, but also to the policy debate on recognition of intangible assets.
The association between management‟s discretionary R&D accounting choice and the firm‟s concurrent market values as reflected in its share price was examined by Ahmed and Falk (2006). Sample of the study was limited to the period ending 1999, because the Australian Standards Board restricted the flexibility of capitalisation in 1999. Similar to prior studies in this area, they also adjusted and applied Ohlson‟s (1995) model to the specific circumstances. The study followed the path paved by Penman and Sougianis (1998) and utilised earnings as a proxy for expected earnings. The results indicate the following:
1. Managerial discretionary accounting practice, capitalising or expensing R&D, demonstrates greater value relevance than accounting figures that are the product of mandatory R&D expensing;
2. Managerial discretionary capitalised R&D accounting figures demonstrate higher association with market share prices than managerial discretionary expensed expenditure;
3. The strength of the association between R&D accounting figures and the firm‟s market value is higher for firms that are members of the defined industrial group (extractive firms) than for the general population of firms; and
4. R&D capitalised expenditure is positively and significantly associated with the firm‟s future earnings.
Ahmed and Falk‟s findings suggest that allowing managers to credibly to signal their superior information by either capitalising successful R&D; or expensing unsuccessful R&D would reduce information asymmetry between managers and the firm‟s contracting parties and is likely to enhance firms‟ financial statements relevance, capital markets‟ efficiency and resource allocation. However, this assumes no moral hazards on the part of the reporting managers, and that managers reporting decisions will not be influenced by opportunistic considerations, that result in unreliable or misleading information. Their findings are supportive of that assumption.
The relationship between voluntarily recognised and disclosed identifiable intangible assets, stock prices and future earnings in Australia over the period 1979-1997 were investigated by Ritter and Wells (2006). The context and the time period during which significant development in the accounting practices applied to identifiable intangible assets occurred. This included the issuance of AASB 1013: Accounting for Goodwill, and the increasing frequency of firms voluntarily disclosing identifiable assets (Wyatt et
al., 2001). The objective of the study was to determine whether the discretion afforded to management to recognise these assets results in presentation of value relevant information, with this being evaluated through associations between identifiable intangible assets and both stock prices and future period earnings.
A similar study of Ji and Lu (2010) reported that the adoption of international accounting standards has changed firms‟ behaviour in reporting intangibles. They examined the impact of reliability of reported intangible assets on the value relevance, in the pre and post-adoption periods of IFRS, using a sample of Australian companies from 2001 to 2008. Results reported that the quality of earnings has improved and the value relevance of intangibles has declined. They conclude that the reliability of the intangible information has significant impact on its value relevance.
Findings indicate that after controlling for income, there is a significant association between voluntarily recognised and disclosed identifiable intangible assets and stock prices. Accordingly, identifiable intangible assets disclosures are value relevant, and although there is an association between these identifiable intangible assets and income they are not substitutes. In addition, that after controlling for current period income, there is a significant positive association between identifiable intangible assets and future period income. This supports the proposition that identifiable intangible assets are relevant to the estimation of future period income, and is suggestive of causality in the above relationship between identifiable intangible assets and stock prices.
Feng and Li (2010) examined whether advertising by pharmaceutical firms is value relevant. The evidence indicated that investors view advertising by pharmaceutical
firms as a source of future economic benefits, where advertising expenditure has a greater association with the firm‟s stock prices and returns than those of non- pharmaceutical firms. Similarly, a study examining the value relevance of major media advertising expenditure by Shah et al. (2009) suggest that advertising expenditure measures are positively associated with market value in the UK.
Since the findings of most of the above studies provide evidence that capitalisation is more value relevant than disclosure, an issue arises whether the value relevance of accounting information is threatened with the new regulatory reforms, which restrict capitalisation. However, with the evidence that market accepts information whether capitalised or disclosed, (example: Han and Manry (2004) and Ritter and Wells (2006)) determining that investors accept the voluntary, non-financial disclosures.