Accounting Comparability And Corporate Innovative Efficiency

Justin Chircop
Lancaster University Management School

Daniel W. Collins
University of Iowa – Department of Accounting

Lars Helge Hass
Lancaster University – Management School

July 16, 2016
Abstract:

We posit that when a subject firm has greater accounting comparability with industry peer firms it facilitates that firm’s learning from peer firm investments leading to better investments by the subject firm. Therefore, we expect firms with greater accounting comparability with industry peers to generate more and higher quality innovations, which are key determinants of corporate innovative efficiency. In the cross-section, we expect that the benefits from learning are likely greater (smaller) when peer-firms are successful (unsuccessful) innovators. Moreover, we expect the benefits of greater accounting comparability to be greater in highly competitive business environments. We find that accounting comparability with peer firms is positively associated with innovative efficiency of subject firms. Moreover, this association is stronger when peers have successful innovations and for firms in industries with high product similarity and strong product market competition.

Accounting Comparability And Corporate Innovative Efficiency – Introduction

This study examines whether accounting comparability of a subject firm with its industry peers enhances the subject firms’ innovative investment efficiency. Following De Franco et al. (2011), we define accounting comparability as the closeness between two firms’ accounting systems. Accounting comparability is enhanced if firms that face similar economic events produce similar accounting numbers. We posit that when a subject firm has greater accounting comparability with industry peer firms it will facilitate that firm’s learning from peer firm investments leading to better investments by the subject firm. Therefore, we expect firms with greater accounting comparability with industry peers to generate more and higher quality innovations, which are key determinants of corporate innovative efficiency.

The approach adopted in this paper differs from that adopted in much of the prior literature that studies how qualities of a firm’s own accounting information affects that firms’ own investment decisions.1 In this paper, we study the effect of a shared qualitative characteristic of accounting, namely cross-sectional comparability of accounting choices of subject firms with industry peers and how this affects subject firms’ innovative efficiency, which is a key determinant of long-term success and competiveness of companies in a rapidly changing global economy.

The results of our study are important for two reasons. First, although the Securities Exchange Commission (SEC, 2000) and the Financial Accounting Standards Board (FASB, 2010) have claimed that accounting comparability fosters more efficient allocation of capital, only a limited number of studies analyze empirically the relationship between accounting comparability and capital allocation. Therefore, the costs and benefits of accounting comparability remain an open issue (Schipper, 2003).

Second, creating an environment that fosters corporate innovation is vital for an economy’s prosperity and competitive advantage (Solow, 1957). In this regard, there is a growing body of research analyzing the determinants of innovation. However, the role of accounting information in fostering innovation and enhancing the innovation process has been largely ignored (Chang et al., 2014). This paper seeks to fill this void.

Accounting Comparability

Using a large sample of U.S. firms for the period 1992 to 2006 we show that when subject firms exhibit greater accounting comparability with industry peer firms, the subject firms generate more patents per invested dollar as well as more citations per invested dollar after controlling for a large number of variables that have previously been documented to affect innovation. This result holds for different definitions of innovative efficiency and different definitions of accounting comparability.

In addition, we also explore situations where we expect the positive relationship between accounting comparability and innovative efficiency to be stronger, i.e. we test for cross-sectional differences. Specifically, we test whether the benefits of peer firm accounting comparability on innovative efficiency is greater when peer firms are successful innovators, when the subject firm is operating in industries with high product similarity, and when the subject firm is operating in industries with strong product market competition, i.e. low concentration. Consistent with our predictions, we find that accounting comparability has a greater (smaller) effect on innovative efficiency when peer firms are successful (unsuccessful) innovators. Using the product similarity and industry competition measures introduced by Hoberg and Philipps (2010, 2015), we find a stronger positive association between accounting comparability and subject firm innovative efficiency in industries with high product similarity and strong product market competition.

Our study makes several contributions to the literature. We contribute to the literature on the benefits of accounting comparability by showing that accounting comparability not only improves the information environment for analysts (De Franco et al. 2011), but also improves investment decision making at the firm level. We therefore provide support for the claims of regulators and standard setters that accounting comparability enhances decision making. Moreover, we contribute to the literature on the effect of how various qualitative characteristics of financial information affect investment efficiency. We extend previous research that shows that financial reporting quality improves a firm’s own investment efficiency (Biddle and Hilary 2006; Biddle et al. 2009) by demonstrating that a shared characteristic of accounting information, namely, accounting comparability with industry peer firms, enhances the innovative efficiency of subject firms. Finally, we add to the growing literature on corporate innovation by identifying a new information-related determinant of innovative efficiency.

The remainder of the paper proceeds as follows. We review the related literature in Section 2 and formulate our hypotheses in Section 3. In Section 4 we present our research design, sample selection and summary statistics. We discuss our findings in Section 5 and conclude in Section 6, where we summarize our findings and draw our conclusions.

Accounting Comparability

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