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Earnings Management: The Effect of Accounting Flexibility on R&D Investment Choices

This paper attempts to document the effects of accounting flexibility on managers' propensity to cut R&D expenditures. Using Barton and Simko's (2002) NOA/Sales variable as a proxy for accounting flexibility, we find that managers are more (less) likely to cut R&D when accounting flexibility is low (high), and that managers prefer the use of accrual to real earnings management given ample accounting flexibility. Our results are consistent with theoretical papers that posit substitution effects between accounting and real earnings management choices, with managers being more likely to cut R&D when the marginal costs of accounting manipulations are low relative to real earnings manipulations.