Informal Regulatory Pressure to Alter Financial Reporting Behavior: The Case of In-Process Research and Development

In 1998, Arthur Levitt, then chairman of the Securities and Exchange Commission (SEC), claimed in a public address that companies making acquisitions frequently allocated overly-large amounts of the purchase price to in-process research and development (IPR&D) instead of goodwill. The result was a one-time charge in the first year followed by several unrealistically rosy years of earnings that were not disturbed by the amortization of goodwill. Levitt warned of increased SEC scrutiny of acquisition purchase price allocations between IPR&D and goodwill. This study investigates the impact of the SEC's informal regulatory pressure by examining acquiring firms' allocation decisions during the three years following Levitt's speech, which we claim marked the beginning of a period of informal regulatory pressure. The results indicate that during this three-year period, the proportion of the acquisition cost firms allocated to IPR&D dropped significantly while the proportion allocated to goodwill and other intangibles increased significantly. Moreover, more-profitable firms began taking bigger IPR&D charges while less-profitable firms began taking smaller charges. These results suggest that the SEC's use of informal regulatory pressure promotes compliance with regulatory requirements.