The Real Effect of Accounting for Software Development Costs on Corporate Innovation

This paper examines the real effects of accounting for software development costs on corporate innovation. We explore the adoption of SFAS 86 (Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed), which requires the capitalization of certain software development costs. We find that public software firms experience improvements in both innovation quantity and scientific quality, and their innovation strategies become riskier and more diversified following the adoption of the standard, compared to other high-tech public firms. Consistent with SFAS 86 helping to reduce agency-related costs, the real effect is more pronounced for software firms with greater financial constraints, higher analyst following, and lower concentrations of institutional shareholding. Overall, our study shows that accounting policies for software development costs have real implications not only for firms’ innovation output but also for their’ choices regarding the types of innovation to pursue.