Does mandating narrative disclosure of innovation help unveil the curtain of R&D expenditure? Evidence from regulation change in China

Abstract

This paper demonstrates that mandating narrative disclosure of innovation can help investors better interpret R&D expenditure, a type of intangible investment with outdated accounting treatment. We construct narrative innovation disclosure measures from annual financial reports based on Word2Vec neural network framework. Using a regulation change in China and an exogenous shock approach, we document that firms increased innovation disclosure after the disclosure became mandated in 2012, and enhanced disclosure mitigated the positive relationship between R&D expenditure and cost of equity capital. This mitigation effect of narrative disclosure of innovation is more pronounced for firms with higher information asymmetry and risker R&D investment.