Managerial Incentives and the Treatment of Pre-Production Expenditure in the Mining Industry

Article excerpt

This study investigates the extent of capitalization of pre-production expenditure for the 2003 financial year by 152 mining sector firms listed in Australia, Canada, South Africa, the United Kingdom and the United States of America. Level of capitalization was associated with higher leverage, lower profitability and reporting a negative earnings figure if pre-production expenditure was written off instead of capitalized. Similar to firms in the oil and gas industry, explorer firms were more likely to capitalize preproduction expenditure than producer firms. Although policy choice is relatively transparent, it appears that managers of producer firms are responding to incentives to present a more favorable view of their financial position and performance.

Key Words: Accounting policy choice; managerial incentives; accounting for mining sector firms; accounting harmonization and standard setting.


Firms in the mining industry have considerable choice in relation to the extent to which they capitalize pre-production expenditure. Studies report that firms throughout the world use a variety of accounting methods (PricewaterhouseCoopers, 1999, 2003; Gerhardy, 1999a; KPMG, 2003), which range from full capitalization of pre-production expenditure to no capitalization (that is, all expenditure is written off). The aim of this study is to investigate explanatory factors for firms' policy choices in relation to pre-production expenditure among an international sample of mining firms.

Prior research on policy choice among extractive industry firms has focused predominantly on US oil and gas producer firms (Sunder, 1976; Johnson and Ramanan, 1988; Malmquist, 1990; Deakin, 1979). In contrast, this study considers mining sector firms from a number of countries including Australia, Canada, South Africa, the United Kingdom (UK) and the United States of America (USA). There are significant differences between oil and gas and mining firms which warrant separate investigation of mining firms. For example, the mining sector includes a greater proportion of small firms, with less national economic significant as well as fewer international activities and investors. In addition, the study includes both producer and explorer firms, which may have different policy choice incentives. An international study is timely given the global nature of many mining firms' operations and current standard setting initiatives in relation to extractive industries (IASB, 2004).

The study investigates the relationship between treatment of pre-production expenditure and firm attributes for 152 firms using 2003 financial year data. The firms were traded on the major stock exchanges of five countries where mining firms are significant in economic or capital market terms, namely Australia, Canada, South Africa, the UK and the USA. The results show that explorer firms were more likely to capitalize pre-production expenditure than producer firms. The extent of capitalization of pre-production expenditure was associated with higher leverage, lower profitability and avoidance of reporting a negative earnings figure. 1

The contribution of the study is to provide empirical evidence about factors influencing policy choice for a cross-country sample of mining firms in a setting where firms have considerable discretion in policy choice. A continuous variable (the proportion of current year pre-production expenditure which is capitalized) is used in addition to dichotomous policy choice variables (such as full cost versus successful efforts) to provide a richer data source for analysis. Thus, the paper extends the existing literature and complements studies of oil and gas firms.

Fields, Lys and Vincent (2001) noted that prior policy choice studies have focused on one policy when several may be relevant and inadequately distinguished between competing explanations for policy choice, such as contracting efficiency, asset pricing and opportunism. …


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