Do Financial Statements have Informational Deficiencies for Intangible-Intensive Firms?

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We explore three issues that are pertinent to the investigation of the value relevance of accounting information for intangible-intensive (INT) firms. First, we explore whether accounting information is less value relevant for INT industries than for non-INT industries. Prior research provides inconsistent findings. To resolve the inconsistency, we examine the three factors that are related to both value relevance and intangible intensity: scale variability, mispricing of share prices and accounting losses. We find that, once we control for the first two factors, the R2 for INT industries becomes less than half of that for non-INT industries. These results suggest that accounting information is severely distorted and does not satisfy informational needs of investors of INT firms. The difference is not driven by loss firms, which are more frequent in INT industries: We also find that the difference in value relevance between the two groups is reduced significantly (but not eliminated) when we capitalize R&D. Second, consistent with abandonment option, we find that book values more than make up for the low value relevance of earnings for loss firms in non-INT industries, but not in INT industries. Third, we investigate the time trend in value relevance and find that it has declined over time for INT industries, while remained almost stable for non-INT industries. Thus, the declining trend documented in prior literature is largely attributable to INT industries. Overall, our results suggest that there are important differences in value relevance between INT and non-INT industries due to the accounting treatment as well as the nature of intangible assets.