A Reexamination of the Incremental Information Content of Capital Expenditures

Abstract

Under generally accepted accounting principles (GAAP), firms must postpone recognition of the earnings effects of capital expenditures until they realize the resulting revenues and expenses. However, if capital expenditures change the profile of future profits, we expect share prices to impound that revision in profitability prior to its recognition under GAAP. This suggests that changes in capital expenditures should have information content beyond current-period unexpected earnings. Prior research considered annual changes in capital expenditures and detected incremental information only in restricted samples. However, we examine more general samples and observe that quarterly as well as annual changes in capital expenditures are informative beyond unexpected earnings. Furthermore, we predict greater incremental information content for fiscal fourth quarter changes in capital expenditures when considering all fiscal quarters simultaneously, because the effect of the earnings recognition delay under GAAP should be magnified for capital expenditures made late in the fiscal year. Our results are consistent with this prediction and inconsistent with the prediction that changes in fiscal fourth quarter capital expenditures reflect lower profitability that results from an inefficient bunching of capital expenditures in the fiscal fourth quarter.