Strategic R&D expense classification and cost of debt

Five percent of Compustat firms report no research and development expenses on Compustat but still file for patents during a given year (hereafter, Pseudo blank R&D firms). Koh and Reeb argue in their 2015 article entitled "Missing R&D" published in the Journal of Accounting and Economics that this missing R&D is not an accidental outcome but instead a deliberate firm choice. I examine whether cost of debt for these pseudo blank R&D firms are different from otherwise similar firms. Pseudo blank R&D firms on average pay 17 basis points less in loan spread compared to control firms. Banks with greater experience operating within a particular industry charge a higher loan spread relative to banks with less experience, suggesting that experienced banks see through the hidden R&D expenses incurred by pseudo blank R&D firms. These findings suggest that banks perceive R&D expenses as a risk factor so that some firms benefit from strategically classifying R&D expenses into other expense categories. These findings are broadly consistent with the notion that managers engage in expense classification shifting.