What Determines the Productivity of Innovation? Focusing on the Role of K-IFRS and Audit Quality

This paper aims to explore how the productivity of R&D investment is affected by the introduction of International Financial Reporting Standards (IFRS) and audit quality. This study is based on a sample of 3,627 firm-year observations of firms listed on the Korea Exchange (KE) from 2007 to 2014. We estimate the relationship between exogenous R&D expenditure (innovation input) and patent acquisition (innovation output) by removing the effects of contributing factors to mitigate endogeneity problem. We find that the productivity of R&D investment is negatively affected by the adoption of Korean International Financial Reporting Standards (K-IFRS) in 2011. Also, the link between R&D and patenting is stronger for firms with Big 4 auditors than those with non-Big 4 auditors. Further tests show that the positive association between R&D and patenting is weakened after K-IFRS was adopted, but only for firms with Big 4 auditors. The link between R&D expenditure and patent acquisition was significantly positive before K-IFRS and their positive association decreases after K-IFRS, but only for firms with Big 4 auditors. This suggests that Big 4 auditors enforce higher earnings quality and therefore managerial discretion in R&D accounting is constrained by Big 4 auditors. Moreover, the innovation productivity is affected by the new accounting standard when a firm’s audit quality is reasonably assured by Big 4 audits. This study adds to accounting and business research by examining the role of audit quality and new accounting standards in innovation productivity. This paper extends the existing academic research on various determinants of corporate innovation activity and its productivity by using a hand-collected patent data in Korea.