Monday, January 19, 2009

Incentivizing R+D by corporations

Problem: Incentivizing R+D by corporations.

Problem detail: One of the major scientific challenges for the United States is a reduction in the level of basic research by corporations. Universities can't do it all themselves, and companies have cut basic research in the interest of improving their bottom line.

My solution: Instead of expensing R+D on GAAP (accounting) financial statements, capitalize it.

Capital expenditures, like renovating buildings or buying machinery, are not listed as "expenses" but instead get capitalized, which means they are added to a corporation's investment base, and get subtracted from the representation of a company's profits as they decrease in value (Depreciation and Amortization, instead of Sales, General and Administrative expenses). Capitalizing R+D means that current R+D doesn't directly affect current earnings, and the R+D you spend now gets amortized over a period of time where (presumably, because of inflation) overall earnings are higher. This reduces executive incentives to cut current basic research to juice a company's short term bottom line for investors. US scientific strength is pivotal to its economic and social strength, so we want corporations to discover things!

This also further incentivizes executives to focus on R+D efficiency because capitalizing R+D means it shows up on balance sheets, which means it shows up in commonly used investment metrics like Return on Equity, Return on Assets and Return on Invested Capital.

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