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The determinants of capitalising development costs in private companies: evidence from Germany

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Abstract

Empirical literature on accounting choices and the use of discretion when accounting for R&D seems to be abundant. However, most of these studies investigate the accounting behaviour of public firms. General research on accounting choices in public and private companies, in contrast, often suggests that incentives for accounting choices in private firms largely differ from those made by public firms due to differences in the group of financial statements’ users. While public companies are driven by capital market forces, private businesses are assumed to be driven mainly by tax and dividend incentives. Hence, empirical evidence on the capitalisation of development costs in public companies cannot be transferred to the context of non-listed companies. Considering their economic importance worldwide and the overall sparse empirical accounting literature covering this sector, our paper investigates the accounting choice of capitalising development costs for private companies in Germany. As this specific accounting option provided by the German Commercial Code has neither an influence on taxable income nor dividend payments, the German context offers an interesting setting for evaluating the drivers of accounting choices in private companies. Based on a sample of 586 large and medium-sized private companies preparing their financial statements in accordance with German GAAP, we find that in the absence of tax and dividend incentives, the determinants for capitalising development costs in public and private firms are similar. Comparable to the results for listed companies, we find private companies to be driven mainly by incentives from debt contracting and the need to ameliorate financial numbers in case of low profitability and negative income. Nevertheless, in contrast to public firms, private companies seem not to be impacted by agency conflicts and the pressure of political costs. Furthermore, we investigate whether private companies would rather use the capitalising option in order to inform their financial statements’ users about the high earnings potential of their R&D or capitalise development costs simply to ameliorate financial numbers, thus misleading their stakeholders as to their true overall performance and success in R&D. We created a matched sample of companies differing solely in regard to R&D success. Our findings show that if companies are otherwise similar, R&D success has no significant impact on the capitalising decision, suggesting that there are companies both using the capitalising option opportunistically and also informing their financial statements’ users.

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Notes

  1. This is based on the idea of the company as a nexus of contracts, as proposed by Coase (1937).

  2. Akerlof (1970) suggests in his seminal paper on the “market for ‘lemons’” that in markets where publicly observable characteristics of traded goods, e.g. companies, cannot be used in order to distinguish them regarding their quality, in the long run transaction costs will increase again.

  3. This is the case, because equity investors and lenders can be assumed not to make totally rational decisions. Thus negative income numbers from the current period may influence their notion of the company in future periods, as suggested by prospect theory (Tversky and Kahneman 1991, 1992; Burgstahler and Dichev 1997).

  4. Nevertheless, the results of the three studies, as well as those of the study performed by Oswald and Zarowin (2007), seem to lack robustness for the R&D case, which may be due to the choice of their proxies or in the case of Oswald and Zarowin (2007) and Oswald (2008) even because of endogeneity issues.

  5. Dafne Neo is a database provided by Creditreform, which amongst other information includes financial data for German non-listed companies, either obtained from financial statements published in the German Electronic Federal Gazette or ascertained by Creditreform.

  6. It needs to be taken into account that our results, therefore, cannot be used for predicting a company's likelihood of being a capitaliser. This problem is also referred to as “oversampling” (Zmijewski 1984, p. 67). Nevertheless, we refrain from including all expensing companies in our sample due to the small proportion of companies capitalising development costs.

  7. In Germany companies which are at least medium-sized have to prepare and publish management reports in addition to their financial statements (Paragraph 264 I GCC) where they have to report on significant research and development activities (Paragraph 289 II GCC).

  8. Further measures for R&D success will be discussed as part of the robustness checks in Sect. 7.

  9. We shortened the original 12 industries to 8 due to very low numbers of observations in certain business sectors.

  10. We did not apply a t test as all independent variables except for AGE are not normally distributed. To test for a potential normal distribution we ran a Kolmogorov–Smirnov test (not reported), resulting in p = 0.645 for AGE, all other p values <0.000.

  11. As all variables except for AGE are not normally distributed, we use Spearman’s Rho instead of Pearson correlations.

  12. We computed the variance inflation factor (VIF) for each independent variable resulting in VIF taking no value above 1.352.

  13. We used a maximum value for the distance between propensity scores of matched pairs of 0.001 in order to guarantee a high degree of accuracy from our matching procedure and excluded correlations between the treatment variable (RD_SUCCESS_DUMMY) and matching variables as far as possible. As we were not able to eliminate all correlations between the treatment variable and matching variables, we ran the matching procedure again, using a maximum value for the distance between propensity scores of matched pairs of 0.0005 (not reported), leading to an amelioration of the matching accuracy. However, this shows no different results regarding the impact of RD_SUCCESS_DUMMY. We refrained from conducting an even more accurate matching, due to our small sample size.

  14. As L_FORM significantly correlates neither with NUM_SH, EXTERNAL_SH nor SH_ABROAD, we keep L_FORM in all three models.

  15. Prior studies have frequently used growth of sales in order to proxy for company growth which, due to non-negativity of sales, allows calculation of growth rates over more than 1 year. Considering our sample companies, we cannot use sales as this is information that medium-sized German companies do not have to disclose in their statements of profit or loss, but are allowed to sum sales, cost of sales and other operating income up to gross profit (Paragraph 276 GCC).

  16. All proxies for company growth capture only underlying effects in the short run and may for this reason not be significant. In any event, we refrained from calculating growth using more than the period of two years as this would reduce our sample size and lead us to eliminate especially young companies which are said to derive significant benefits from capitalising development costs (Deutscher Bundestag 2008).

  17. At most we divide by 20 years, because this is the maximum possible duration of a patent in Germany. Hence all patents being applied for in the last 20 years could be still active.

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Acknowledgments

We gratefully acknowledge helpful comments by the two anonymous reviewers of the Journal of Business Economics, together with those from Tami Dinh, Jürgen Ernstberger, Axel Haller, Ioannis Tsalavoutas and participants at the 9th Workshop on European Financial Reporting 2013 in Valencia, Spain, the 6th Accounting and Audit Convergence Convention in Cluj Napoca 2013, Romania, and the 9th Interdisciplinary Workshop on Intangibles, Intellectual Capital and Extra-Financial Information 2013 in Copenhagen, Denmark.

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  1. University of Bamberg, Chair of International Accounting and Auditing, Feldkirchenstraße 21, 96045, Bamberg, Germany

    Brigitte Eierle & Simone Wencki

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  1. Brigitte Eierle
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Correspondence to Brigitte Eierle.

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Eierle, B., Wencki, S. The determinants of capitalising development costs in private companies: evidence from Germany. J Bus Econ 86, 259–300 (2016). https://doi.org/10.1007/s11573-015-0778-0

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