Are In-Process Research and Development Charges Too Aggressive? Evidence from Acquired Firms' R&D Expenses and Acquirers' Iprd Charges
30 Pages Posted: 21 Oct 2005
Date Written: September 21, 2005
In-process research and development is the value allocated to incomplete research and development projects in acquisitions treated as purchases, and charged to expense by the acquirer at the acquisition date. Researchers have documented the benefits to acquiring companies from large IPRD charges, and in 1998, the SEC expressed concern that companies inflate future earnings by overstating their IPRD charges. In this paper, we investigate the IPRD charges for 144 acquisitions of target companies with publicly available information about their previous R&D costs. We find a positive relation between IPRD charges and the prior R&D costs of the acquired firm, consistent with appropriate IPRD reporting, on average. However, we identify 23 acquisitions with high IPRD but low prior R&D costs, suggesting overly aggressive write-offs, and justifying SEC concerns. These acquirers faced higher investor expectations for future earnings and had higher pre-write-off earnings compared to acquirers reporting normal IPRD. Consistent with SEC scrutiny of IPRD leading to more appropriate reporting, the number of acquisitions with excessive IPRD decreased significantly after 1998. Finally, we observe that investors adjusted the relation of earnings and returns to account for the increase in future earnings arising from write-offs of IPRD.
JEL Classification: M41, M43, G38, K22, G24
Suggested Citation: Suggested Citation