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Journal of Human Resource Costing & Accounting

Intellectual capital and the capital market: a review and synthesis


Subhash Abhayawansa, James Guthrie,
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Subhash Abhayawansa, James Guthrie, (2010) "Intellectual capital and the capital market: a review
and synthesis", Journal of Human Resource Costing & Accounting, Vol. 14 Issue: 3, pp.196-226, https://
doi.org/10.1108/14013381011095472
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JHRCA
14,3 Intellectual capital and the capital
market: a review and synthesis
Subhash Abhayawansa
196 Faculty of Business and Enterprise, Swinburne University of Technology,
Hawthorn, Australia, and
James Guthrie
Faculty of Economics, University of Bologna, Bologna, Italy

Abstract
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Purpose – The purpose of this paper is to review and synthesise current knowledge on the
importance of intellectual capital (IC) information to the capital market.
Design/methodology/approach – The paper is by way of literature review. It reviews the
empirical research literature from different methodological strands and synthesises the findings to
provide evidence on the impact/importance/usefulness of IC from a capital markets perspective.
Findings – Importance of IC information has been examined using various research methods
including capital markets research, questionnaire surveys, face-to-face interviews, experimentations,
verbal protocol analysis and content analysis of analyst reports. These studies provide evidence on the
usefulness/importance of many types of IC information. Also, evidence from IC disclosure studies on
initial public offering prospectuses sheds light on perceived importance of types of IC information to
the capital market. However, there is a scope for more research to refine the current understanding of
the importance of IC to the capital market.
Practical implications – By reviewing and synthesising the literature, this paper provides an
important source of reference for future researchers and policy makers who wish to formulate
guidelines for IC reporting to better meet the information needs of capital market actors. It also
highlights future research directions.
Originality/value – This is the first-published literature review on the importance of IC that
provides a comprehensive review of studies adopting various research methods. Prior reviews have
been limited to value-relevance and/or predictive ability studies.
Keywords Capital markets, Intangible assets, Intellectual capital, Research
Paper type Literature review

1. Introduction
Academics have debated the relevance of accounting information for valuing firms.
The majority of these studies document a weak earnings-return association (Amir and
Lev, 1996) and a temporal decline in the association between stock prices and both
earnings and book values (Brown et al., 1999; Core et al., 2003; Ely and Waymire, 1999a;
Lev, 1989; Lev and Zarowin, 1999)[1]. It has been found that the decline in
value-relevance of accounting measures is sharpest for firms that have increased their
intangibles intensity over time (Lev and Zarowin, 1999) indicating the increasing role
played by intellectual capital (IC)[2] in determining firm value, particularly in such firms.
Journal of Human Resource Costing & Given that IC encompasses future value creation potential and capital market valuations
Accounting are essentially forward-looking, capital market actors ought to use IC information in
Vol. 14 No. 3, 2010
pp. 196-226 their valuations and investment decision making.
q Emerald Group Publishing Limited The widening gap between the book value and market value of firms’ equity in many
1401-338X
DOI 10.1108/14013381011095472 countries is commonly discussed as evidence of the inadequacy of financial accounting
information for firm valuation and the increasing need for IC information. Lev (2001) IC and the capital
showed that the average price-to-book ratio of the S&P 500 companies has gradually market
increased almost sixfold in the period from 1977 to 2001. Beattie and Thomson (2005)
document that companies in knowledge-intensive industries, such as pharmaceutical
and media, have higher price-to-book ratios when compared to other industries. They
further identified that companies in less knowledge-intensive industries, such as
insurance and real estate, record the lowest price-to-book ratios. 197
While the significance of IC in explaining the gap between the book and market value
of companies is debated in the literature, empirical evidence is limited. In one of the few
reported studies, Lev and Sougiannis (1999) found that innovative capital[3] is
significantly associated with market returns, and reduces the value-relevance of
price-to-book ratio for all firms in their sample. Further, for firms intensive in R&D, they
found that, innovative capital replaces the value-relevance of price-to-book ratio
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altogether. This supports an earlier study by Hirschley and Weygandt (1985) that
reported a statistically significant positive association between price-to-book ratio and
R&D intensity. On a related note, Beattie and Thomson (2005) examined reasons for
extreme changes in price-to-book ratios of companies. They argue that events causing
the market to reassess the value-creation prospects of a company (e.g. developing a new
business model, acquisition, divestments, etc.) and the significance of knowledge-based
assets contribute to these extreme changes.
In support of the contention that IC information is incorporated in market values,
research studies document that after financial information is adjusted for the
expensing of intangible assets, earnings and book values explain security prices and
equity values (Abrahams and Sidhu, 1998; Amir and Lev, 1996; Lev and Thiagarajan,
1993; Livnat and Zarowin, 1990; Ritter and Wells, 2006). For instance, it has been found
that adjusting earnings for R&D accruals and sales, general and administration
expenses, which predominantly include investments in certain IC (e.g. customer base,
business collaborations and acquisition of licences), improves the explanatory power of
accounting earnings as a measure of performance in relation to market returns
(Abrahams and Sidhu, 1998; Amir and Lev, 1996). As these comprise just a fraction of
IC of a firm, a significant proportion of the market value of firms’ equity remains
unexplained even after these adjustments. Amir and Lev (1996) found that financial
information and non-financial information (NFI)[4] combined together can better
explain market value. Since then, many studies have documented the importance of
information on IC for the efficiency of the capital market. Whilst some of these studies
have resorted to the examination of value-relevance and predictive ability of types of
information, others have investigated the perceived usefulness/importance of types of
information to capital market actors, or alternatively examined the information they
have used. The need for assessing the relevance of IC for the purposes of equity
valuation in capital markets has been voiced by policy makers and proponents of IC
research (MERITUM, 2002).
The purpose of this paper is to review and synthesise the current knowledge on the
importance of IC information to the capital market. By reviewing and synthesising
the literature on this topic, this paper provides an important source of reference for
future researchers and highlights future research directions. Also, it acts as a reference
for policy makers who wish to formulate guidelines for IC reporting to better meet the
information needs of capital market actors. This review differs from the previous ones
JHRCA (Ashton, 2005; Canibano et al., 2000)[5], in that it is not limited to capital markets
14,3 research, and it provides a comprehensive review of studies by research method
adopted (i.e. surveys, interviews, experiments, verbal protocol and content analysis).
The remainder of this paper is organised as follows. Section 2 reviews prior capital
markets research studies that provide evidence on the importance of different types of IC
items in determining the market value of firms. Section 3 reviews the literature on the
198 predictive ability of types of IC information. Although this genre of research does not
directly investigate, the capital market impact of IC it highlights potentially important
IC items that may invariably be counted in the determination of the market value of
equity. Section 4 provides a detailed review of the literature on the importance of NFI,
with the focus on types of IC information, to capital market participants. This review is
organised according to the dominant research method adopted. Section 5 contains a
discussion of IC information disclosed in initial public offering (IPO) prospectuses as it
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relates to meeting information needs of the capital market. The final section provides a
summary and opportunities for future research.

2. Value-relevance of intellectual capital


The aim of value-relevance studies is to assess the usefulness of accounting and
non-accounting numbers in equity valuation (Holthausen and Watts, 2001).
Value-relevance research has two strands: event studies (or marginal information
content studies) and association studies (Holthausen and Watts, 2001)[6]. The event
study method is used to investigate whether the release of a particular information item
(i.e. an event such as a brand extension announcement), conditional on other information
releases, is associated with changes in the level or variability of a stock price over a short
window around the event (Kothari, 2001). If the level or variability of stock price changes
around the event date is significant, it is said that the event has information content on
the amount, timing, and/or uncertainty of cash flows (Kothari, 2001). According to the
association study method, when a particular information item (e.g. customer satisfaction
measure) has a predicted association with equity value or changes in the equity values
over a long window (e.g. one year), it is said to have information content and thus is
value-relevant (Barth et al., 2001; Kothari, 2001).
Although value-relevance studies have primarily been used in relation to financial
accounting numbers, researchers have also examined the explanatory power of various
types of IC, separately, as well as in groups, using proxies (Holthausen and Watts, 2001).
Table I lists research studies that have found particular IC items to be value-relevant on a
standalone basis. These studies are reviewed in the following two subsections.

2.1 Association studies


As shown in Table I, association studies have found significantly positive associations
between stock prices/returns and various IC items or IC surrogates. For instance,
Wang (2008) examined the association between IC (and its components) and the market
values of companies in the electronics industry. All constituents of IC in this study,
namely, human capital (proxied by number of employees, sales per employee and net
income per employee); customer capital (proxied by sales growth rate and advertising
expenses); innovation capital (proxied by R&D); and process capital (proxied by
selling, general and administrative expenses (SGA) per sales and per employee) were
found to be positively related to the market value.
IC and the capital
IC items Association studies Event studies
market
Internal capital
Intangible assets Ritter and Wells (2006)
Godfrey and Koh (2001)
Barth and Clinch (1998)
R&D expenditure Lev and Sougiannis (1996, Chan et al. (1990) 199
1999)
Abrahams and Sidhu (1998) Doukas and Switzer (1992)
Chauvin and Hirschey (1993)
Bublitz and Ettredge (1989)
Wang (2008)
Patents and patent citations Deng et al. (1999) Austin (1993)
Quality/quality awards Aaker and Jacobson (1994) Hendricks and Singhal (2001)
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Hendricks and Singhal (1996)


Software development costs Aboody and Lev (1998)
Innovations Liu (2006)
IT investments/computer capital Brynjolfsson and Yang (1997) Dos Santos et al. (1993)
SGA/sales Wang (2008)
SGA/employees
External capital
Advertising expenses Lev and Sougiannis (1996)
Wang (2008)
Brand values/quality Barth et al. (1998) Lane and Jacobson (1995)
Kallapur and Kwan (2004)
Customer satisfaction Ittner and Larker (1998) Ittner and Larker (1998)
Celebrity endorsement Agrawal and Kamakura
announcements (1995)
Sponsorship announcements Mishra et al. (1997)
Customer base/penetration Amir and Lev (1996)
Human capital
Top management changes Dedman and Lin (2002)
Furtado and Rozeff (1987)
Reinganum (1985)
Denis and Denis (1995)
No. of employees Wang (2008) Table I.
Sales/employees Prior research on the
Net income/employee value-relevance of IC

In an Australian setting, Ritter and Wells (2006) investigated the association between
stock prices and voluntarily recognised and disclosed identifiable intangible assets,
such as patents, licences, brand names, and trademarks in the balance sheet of large
listed companies between 1979 and 1997. They found a significantly positive association
between voluntarily recognised and disclosed identifiable intangible assets and stock
prices. Further, they found that the introduction of Australian Accounting Standards
Board (AASB) Standard 138: Intangible Assets (Australian equivalent of IAS 38)
restricted the recognition of most intangible assets and reduced the value-relevance of
financial statements. Also, Godfrey and Koh (2001) found that capitalisation of
intangible assets provides information relevant for valuation of large firms, and that
information was incremental to other balance sheet items. Further, Barth and Clinch
(1998) provided evidence of a significant relationship between revaluation of intangible
JHRCA assets and security returns. On the contrary, Ely and Waymire (1999b) documented that
14,3 capitalised intangible asset values are not significantly associated with stock prices.
However, Zarowin (1999) suggests that the conclusions in Ely and Waymire (1999b) can
be attributed to sample selection bias, where firms that do not capitalise intangible
assets can be more successful than the firms that capitalise intangibles (i.e. firm success
would be a correlated omitted variable in the regression). He argues that in the era prior
200 to the Securities Exchange Commission, firms that were more successful may not have
capitalised intangible assets.
The empirical literature has also examined the value-relevance of specific intangible
assets. Among various intangible assets, R&D, brands and patents have been
extensively studied (Maines et al., 2003). It has been found that the market value
incorporates the future cash flows associated with expenditure on R&D despite
accounting standards prohibiting capitalisation of R&D expenses in the USA (Bublitz
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and Ettredge, 1989; Chauvin and Hirschey, 1993; Lev and Sougiannis, 1996, 1999). In the
Australian context, under a previous regulatory regime, where capitalisation of R&D
expenses was based on management discretion (i.e. under AASB1011 – Accounting for
Research and Development Costs)[7] Abrahams and Sidhu (1998) found that capitalised
R&D expenses are value-relevant.
Looking at the value-relevance of brands, Barth et al. (1998) found that brand value
estimates produced by a third party are value-relevant. Also, capitalised, acquired as
well as self-generated brands in the UK were found to be value-relevant, and news about
brand capitalisation has been observed to convey information to the stock market
(Kallapur and Kwan, 2004). Empirical evidence also exists on the value-relevance of
advertising expenses (Chauvin and Hirschey, 1993; Lev and Sougiannis, 1996)
indicating that costs associated with attracting customers and building brand loyalty
are considered as IC investments by the capital market.
Other IC items found to be value-relevant in the literature include capitalised software
development costs (Aboody and Lev, 1998), patents and patent citations (Deng
et al., 1999), customer satisfaction measured by the American Customer Satisfaction
Index (Ittner and Larker, 1998)[8], customer-base (POPS)[9] and customer penetration
rates in the cellular operator industry (Amir and Lev, 1996), and perceived quality of a
firm’s products (Aaker and Jacobson, 1994). Brynjolfsson and Yang (1997) observed that
computer capital, which results from the computerisation of a firm’s operations
(i.e. intellectual, cultural, organisational and inter-organisational changes that are
needed to make computers effective), is strongly related to the market value of
companies, suggesting that computerisation creates IC.

2.2 Event studies


Table I highlights that the announcements relating to external, internal and human
capital are associated with positive market returns. Within the external capital category,
brand extension announcements (Lane and Jacobson, 1995), release of customer
satisfaction data (i.e. American Customer Satisfaction Index) (Ittner and Larker, 1998),
celebrity endorsements (Agrawal and Kamakura, 1995), sponsorships (Mishra et al.,
1997), and winning quality awards used as a proxy for total quality management
(Hendricks and Singhal, 1996, 2001) are associated with post-announcement positive
returns. Announcements of innovation news in the biotechnology industry (Liu, 2006),
innovative information technology investments (Dos Santos et al., 1993), R&D spending
(Chan et al., 1990; Doukas and Switzer, 1992), and patent issuances (Austin, 1993) are IC and the capital
among the internal capital-related announcements that are found to be value-relevant in market
event studies. In addition, Dumay and Tull (2007) found that price-sensitive
announcements made to the Australian Securities Exchange by companies about
internal capital information are associated with cumulative abnormal returns.
Event studies on human capital are mainly limited to top management human capital.
These studies investigate the shareholder wealth effect of companies announcing top 201
management appointments and departures. Research shows a negative market reaction to
chief executive officer (CEO)/managing director (MD) departures and a positive reaction to
CEO/MD appointments (Dedman and Lin, 2002; Furtado and Rozeff, 1987). The positive
market reaction to the appointment of a CEO through internal promotions is found to be
stronger than the positive market reaction to an external appointment (Furtado and
Rozeff, 1987), implying that promotions are regarded as news about a firm’s human capital
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investment program and existence of firm specific human capital. On the other hand, when
a CEO is forced to resign due to the poor financial performance of the company, a positive
market reaction has been documented (Denis and Denis, 1995). This probably suggests
that the capital market sees a departure of a poorly performing CEO as extinguishing an
intellectual liability. Further, Reinganum (1985) found that the simultaneous
announcement of a CEO departure and an appointment of a successor results in no
significant share price reaction, implying that the negative reaction to the CEO departure
is neutralised by the positive reaction to the new appointment. These findings suggest that
the human capital in top management is value-relevant.

3. Predictive ability of intellectual capital


Predictive ability studies investigate how current information corresponds to future
financial performance (compared to market price/return, as in value-relevance studies)
that may ultimately be incorporated in the share price of companies (Maines et al.,
2002). Some of the research of this genre has found that IC can be a leading indicator of
firms’ financial performance. For instance, Ashton (2005)[10] reviewed predictive
ability research conducted during the two decades to 2005, and contended that many IC
items are positively associated with financial performance (Canibano et al., 2000).
Examining the predictive ability of external capital items, Srivastava et al. (1998)
provided empirical evidence suggesting that customer relationships (brand equity),
channel relationships (channel equity), and partner relationships influence firm value
by accelerating and enhancing cash flows, lowering the volatility and vulnerability of
cash flows, and increasing the terminal value of cash flows. Moreover, research has
found a positive association between customer satisfaction measures and current and
future financial performance (Anderson et al., 1994, 1997; Behn and Riley, 1999; Helmi,
1998; Ittner and Larker, 1998; Yeung and Ennew, 2001). Still in relation to customer
satisfaction, Schefczyk (1993) found that passenger focus in companies in the airline
industry is associated with the profitability of the firm, indicating that customer
orientation is a leading indicator of financial performance. Also, product and process
quality, measured as the winning of quality awards, has been found to be associated
with firm profitability (Hendricks and Singhal, 1997).
In relation to HumC, Bilmes et al. (1997, p. 1) contended that “companies which place
workers at the core of their strategies produce higher long-term returns to shareholders
than their industry peers”. Prior research studies have found statistically significant
JHRCA association between firms’ financial performance and human resource management
14,3 (HRM) strategies and practices. For instance, Terpstra and Rozell (1993) found that
extensiveness of recruiting and use of formal selection procedures have a positive
impact on company profits. Similarly, performance appraisal systems linked to
compensation are found to be consistently connected with increased firm profitability
(Gerhart and Milkovich, 1992). Further, Huselid (1995) examined the combined impact
202 of a range of HRM practices proven to be related to financial performance on a
standalone basis, described as high performance work practices, on employee turnover,
productivity and corporate financial performance. The results revealed that investments
in such practices are associated with lower employee turnover, greater productivity and
increased corporate financial performance measured in terms of sales, market value and
profits. In addition, positive relationships between employee satisfaction, customer
satisfaction and financial performance are documented in Neely and Al Najjar (2002).
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The predictive ability of human capital is further justified by Brynjolfsson and


Hitt (1996), who found that spending on information systems staff generates higher
returns than spending on other labour expenses.
Studies on the predictive ability of internal capital items are comparatively scarce,
possibly due to the difficulty of measuring aspects of internal capital, such as business
models, corporate culture, management processes and management philosophy. Among
the few reported studies, Bharadwaj et al. (1999) found information technology
investments to be associated with financial performance. Similarly, Brynjolfsson and Hitt
(1996) documented an association between computer capital and financial performance.

4. Importance of IC information to capital market actors


Conventional value-relevant research primarily concentrates on input and output measures
of corporate value creation which are visible and concrete (Holland, 2006a). As a result,
some IC which is not amenable to measurement goes without being researched altogether
despite their potential contribution to firm value. Therefore, the utility of value-relevance
literature to the understanding of the usefulness of IC in company valuation is limited.
Researchers have used other research methods to overcome this problem.
This section reviews the research literature on the usefulness/importance of various
types of information to capital market actors, with a special focus on IC information. The
studies reviewed in this section mainly concern information use of financial analysts
(sell- and buy-side) and fund managers as they are the considered to be most influential
capital market participants (Schipper, 1991). Table II categorises literature reviewed in
this section according to the research method adopted in the study. Each research
method provides a unique perspective to understand the types of information used by or
useful/important to capital market participants. Whilst the scope of many of these
studies is not limited specifically to the investigation of IC information, they are helpful
in understanding the types and extent of IC information important to the capital market.
As shown in Table II recent decade has seen an increase in the use of content
analysis in the investigation of the importance of types of information. Moreover,
research studies exclusively investigating IC information use have predominantly
utilised content analysis of analyst reports. Hence, the review done in this section is
naturally biased towards content analysis-based literature. Only few studies have
employed interviews with analysts and fund managers to provide insights on their use
of different types of information, let alone IC information. Although other methods
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Authors Nature of the study

Survey-based studies
Buzby (1974) Assesses the importance of 38 financial and NFI items, which might appear in an annual report, to professional
financial analysts
Benjamin and Stanga (1977) Assesses the importance of 79 information items that might be needed by bankers and financial analysts for decision-
making purposes
Belkaoui et al. (1977) Compares the importance attributed to 29 information items between Canadian and US financial analysts and North
American and European financial analysts
Firth (1978) Assesses the importance of 75 information items, which are, or could be, disclosed in an annual report, to sell- and
buy-side analysts and bank lending officers
Arnold et al. (1984) Explains the procedures used by financial analysts to appraise equity of companies and to identify differences
between the procedures adopted by US and UK financial analysts. This study looked at the valuation methods
adopted by analysts, features of analysts’ forecasts, influence of various information sources and analysts’ assessment
of provision of a number of information items by company management
Arnold and Moizer (1984) Investigates the valuation methods adopted by analysts, features of analysts’ forecasts, influence of various
information sources to analysts and analysts’ assessment of provision of a number of information items by company
management
Chugh and Meador (1984) Examines the relative importance to financial analysts of short- versus long-terms economic, industrial and financial
variables in the stock valuation process. This study also looked at the relevance of a company’s long-term strategic
plan, the strategic planning system and quality of information provided by companies for stock valuation
Moizer and Arnold (1984) Compares the differences between portfolio managers and information intermediaries in relation to the share
appraisal methods adopted, frequency of different financial variables are forecasted, influence of various information
sources and assessment of provision of information by company management
Chang and Most (1985) Examines the investment objectives of different types of investors, their views on relative importance of various
information sources, items in the corporate annual report, the 10-K report, interim reporting (in the USA), importance
of published forecast information. Also, the study investigated the differences between investor groups in relation to
these aspects
Pike et al. (1993) Compares the approaches to stock valuation and information sources and types used by UK and German investment
analysts
Olbert (1994) Investigates the appraisal methods used, factors considered in share appraisal, types of forecasts made and frequency,
and the relative importance of various sources and items of information. The results of this study, which was in
relation to Swedish financial analysts, was compared with financial analysts from the USA and UK as found in
Arnold et al. (1984)
(continued)

reviewed by research
IC and the capital

A classification of studies

method
market

203

Table II.
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14,3

204

Table II.
JHRCA

Authors Nature of the study

Eccles and Mavrinac (1995) Examines corporate managers’ and financial analysts’ opinions on disclosure regulations and communications to the
capital market
Dempsey and Gatti (1997) Examines the differences in analysts’ use of 63 financial and non-financial strategic performance variables in relation
to their frequency of use, perceived predictive value, and ease of acquisition. Also, this study looked at the
simultaneous influence of information characteristics on analysts’ use of various information measures and the gap
between information usefulness and information availability
Orens and Lybaert (2010) Investigates the determinants of sell-side analysts’ use of NFI
Interview-based studies
Hellman (1996) Examines what information causes investors to act by buying or selling shares. The study uses a case study approach
and investigates reasons behind three large trades made by a Swedish institutional investor
Barker (1998) Builds a grounded theory of market for information by interviewing finance directors, sell-side analysts and fund
managers. The study explores a range of issues in relation to information provision and use
Holland (1998) Investigates the private disclosure process to institutional investors using interviews with 33 senior executives in UK
companies. The study discusses the aims and objectives of private meetings, costs, benefits and choices of disclosure
channels, types of information released in meetings, and constraints to disclosure from the perspective of disclosing
companies
Holland and Johanson (2003) Investigates how value relevant information on IC is created and processed by sell-side analysts and fund managers,
and barriers likely to be faced by them in doing so
Johansson (2007) Explores, through interviews with sell-side analysts, several research questions in relation to the value-creation chain
in the stock market. The research questions include:
RQ1. Which values are added through the sell-side analysts’ relational capital?
RQ2. How are values added through relational capital?
RQ3. Which values are added to the analysts through “company relational capital”?
RQ4. How these values are created?
RQ5. What values are provided by analysts to clients?
RQ6. How these values are distributed to clients?
Almqvist and Henningsson (2009) Explores how capital market actors deal with information on personnel and work environment. The study uses
interviews with 14 fund managers and two bankers
Campbell and Slack (2008) Examines the usefulness of information reported in the narrative form in annual reports to sell-side analysts.
The study involves interviews with 19 sell-side analysts
(continued)
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Authors Nature of the study

Experiment-based studies
Pankoff and Virgil (1970) Investigates the usefulness of accounting and other NFI to buy- and sell-side analysts. The laboratory experiment
requires analysts to forecast the stock price of firms and make investment decisions
Mear and Firth (1990) Examines the systematic individual differences in financial analysts’ decision behaviour
Thomas (2003) Explores the impact of availability of NFI on forecasting revenue and earnings, investment recommendations and
estimating beta risk of a firm by fund managers and buy-side analysts
Ghosh and Wu (2007) Examines how IC information is considered in firm valuation. Also, it investigates the impact of the level of IC and
financial performance measures on financial analysts’ investment recommendations and the investment horizons
Coram et al. (2009) Examines the impact of disclosure of NFI on stock price determination and the impact of the provision of an assurance
report on NFI
Coram (2010) Examines how enhanced disclosure of value-relevant non-financial performance indicators affects the stock-price
estimates of non-professional and professional investors
Protocol analysis based studies
Day (1986) Assesses the usefulness of information contained in annual reports to investment analysts. The study also examines
the forecasting process of investment analysts
Anderson (1988) Assesses the information search and evaluation behaviour of financial analysts. The study required financial analysts
to analyse an IPO of an equity security in order to observe their problem-solving behaviour. The study compares
information usage of professional versus non-professional financial analysts
Bouwman et al. (1995) Examines buy-side analysts’ and fund managers’ information usage in the investment-screening phase. It particularly
concerns the use of GAAP-based information versus qualitative information (non-GAAP information)
Content analysis-based studies
Govindarajan (1980) Investigates the relative use of earnings versus cash flow information by sell-side analysts by content analysing
976 analyst reports
Previts et al. (1994) Investigates the information needs of sell-side analysts by content analysing 479 analyst reports. It looks at the types
of information on which analysts base their investment recommendations and how the information is used for
company valuation
Bricker et al. (1995) Explores the meaning of “earnings quality” to sell-side analysts and their preferences for accounting methods by
content analysing 479 analyst report
Rogers and Grant (1997) Investigates the relevance of information provided in annual reports by analysing the types of information in analyst
reports, and whether the potential source of that information is the annual report. It involves content analysis of 187
analyst reports and tracing back the information found in them to respective annual reports
(continued)
IC and the capital
market

205

Table II.
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14,3

206

Table II.
JHRCA

Authors Nature of the study

Breton and Taffler (2001) Investigates the types of information (both financial and non-financial) that effect sell-side analysts’ investment
recommendations. The study looks at the information types that can distinguish between analysts’ buy, hold and sell
recommendations in order to understand decision relevant information
Arvidsson (2003) Chapter 4 of this published thesis investigates the disclosure of information on intangibles in analyst reports from
knowledge-intense companies in Nordic countries and determinants of such disclosure. A content analysis is
performed on 105 analyst reports
Fogarty and Rogers (2005) Examines how institutional theory can explain sell-side analysts’ work by testing four hypothesis
H1. Analysts are heavily dependent upon corporate managers for their information, and recognize this dependency in
their reports
H2. Analysts depend considerably on the past repeating itself
H3. Analysts will be considerably more influenced by good news than by bad news pertaining to past corporate
performance
H4. Analysts will comment favourably upon the broad range of future plans for change, including mergers and
acquisitions
Garcı́a-Meca (2005) Examines the relationship between IC information disclosed to sell-side analysts by companies through analyst
presentations and IC information used by sell-side analysts as found in their reports
Abdolmohammadi et al. (2006) Explores the nature of the information (financial and non-financial) that is disseminated through quarterly
recommendation reports of sell-side analysts. It also traces the information found in analyst reports to Securities and
Exchange Commission (SEC) fillings in order to examine the extent of the gap between the information in analyst
reports and that found in SEC fillings
Flöstrand and Ström (2006) Investigates the types of NFI used by sell-side analysts by content analysing 200 analyst reports. It also compares this
information to that found in the annual reports of the same companies to find any association between the two
sources. In addition, the study investigates determinants of provision of NFI in analyst reports
Flöstrand (2006) Examines the perceived usefulness of different categories of IC indicators of sell-side analysts by content analysing
250 analyst reports
Garcı́a-Meca and Martı́nez (2007) Investigates whether sell-side analysts use IC information in making investment recommendations and the types of IC
information they use most. Also, the study examines whether certain firm characteristics effect the use of IC
information by sell-side analysts
(continued)
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Authors Nature of the study

Mixed methods based studies


SRI International (1987) Examines investors’ (both individual and professional) information needs and the role of the annual report as a vehicle
for financial communication. Research methods used in this study include personal interviews, focus group
discussions and surveys with buy-side professionals, sell-side analysts, financial advisors, individual investors and
corporate executives
Gniewosz (1990) Investigates the use of accounting information and information from other sources in the equity investment decision
process of an institutional investor. Case study method is used for data gathering, which includes participant
observation, analysis of written documents, and verbal protocol analysis
AICPA (1994) Investigates the information needs of investors and creditors to assess the relevance and usefulness of business
reporting. The study made recommendations to improve business reporting to better meet user needs. Research
methods include content analysis of analyst reports, analysis of business and investment models, interviews with
investors, creditors and advisors, and surveys
Low and Siesfeld (1998) Examines how investors use non-financial performance information, the extent to which it affects their investment
decisions, and the specific types of information that most affect their evaluation of firms. The study included
interviews with fund managers, content analysis of analyst reports and a survey of fund managers
Orens and Lybaert (2007) Using content analysis of analyst reports and surveys with sell-side analysts, this study provides evidence on sell-side
analysts’ use of voluntary NFI and the change in the use of this information over time. Also, the study examines
whether sell-side analysts’ usage of voluntary NFI is related to forecast accuracy
Nielsen (2008) Examines the differential use of NFI between fundamental and recurrent analyst reports. It also compares NFI found
in analyst reports to that disclosed in the corresponding annual report to investigate differences in disclosure patterns
between the two documents. This study uses content analysis of analyst reports and annual reports written on a
selected case company and surveys with the analysts who have written the reports
IC and the capital
market

207

Table II.
JHRCA have not yet been used to examine the importance of IC information in specific, studies
14,3 utilising them in the examination of the relevance of NFI reveal interesting insights
into the importance of certain IC information.

4.1 Survey-based literature


In survey research, respondents rank information items on a Likert scale based on their
208 perceived importance or usefulness. The importance of each information item is then
determined based on its mean rank relative to that of other items. This method presumes
that the types of information sell-side analysts perceive as important are what they
actually use in their analysis. Therefore, validity of findings in survey-based studies is
largely dependent on sell-side analysts’ self-insight – the ability to communicate one’s
own judgements. However, research evidence suggests that information needs of analysts
can only be elicited to a certain extent from their subjective opinions (Mear and Firth, 1987,
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1990). This remains a limitation in the use of surveys in investigating the importance of IC
information to analysts.
Evidence from surveys on the importance of NFI suggests that IC information is
prevalent among the NFI items that are identified as useful, and this has been the case
even three decades ago. For instance, Benjamin and Stanga (1977), Buzby (1975),
Dempsey and Gatti (1997) and Firth (1978) investigated the usefulness/importance of a
comparable set of information items. They all reveal that several IC information items
are perceived as very important/always used, while few IC information items are
considered as either moderately or less important.
More recently, Orens and Lybaert (2007) found analysts to be most concerned with IC
information in annual reports, such as “broad objectives and strategy”,
“forward-looking information”, “reasons for changes in the financial, operating and
performance related data”, “scope and description of the business”, and “properties and
impact of industry structure on a company”. Similar results have been reported in a
study conducted two decades ago by SRI International (1987). They observed that NFI
such as “recent developments and outlook for a company”, “company’s market
position”, “company’s risk exposure”, and “recent events affecting a company” were
considered as highly important by professional investors. On the subject of the
usefulness of IC disclosed in annual reports, Firth (1978) reported that many NFI items
that can be included in an annual report (e.g. “information relating to company directors
and managers”, “products”, “market share”, “dependence on customers”, “acquisitions”,
“order backlogs”, “R&D and capital expenditure”, “company assets”, “geographical
spread”, and “company segments”) are considered important to analysts.
Chugh and Meador (1984) observed that analysts emphasise qualitative predictors
of long-term growth and earnings in stock value determination. According to them,
these predictors include IC information such as “quality and depth of management”,
“company’s market dominance”, and “company’s history of achieving stated goals
(strategic credibility)”. Analysts also value information on companies’ strategic plans
and the planning system (Chugh and Meador, 1984). Dempsey and Gatti (1997)
conducted a questionnaire survey using an instrument comprising 63 financial and
non-financial measures that are considered as predictors of long-term performance in
industries other than the financial services sector. They found that analysts use a
broad range of indicators to assess long-term performance, and include many IC items
including “management experience”, “market share”, and “brand awareness”.
4.2 Interview-based literature IC and the capital
Interview-based studies find that not only IC information is considered in the overall market
scheme of things in investment decision making but also such information sometimes
triggers fund managers equity trade decisions (Hellman, 1996).
Interviews with sell-side analysts reveal that IC information is mainly used to
assess a company’s performance in the long term. For instance, Nielsen (2008) found
information about “company management”, “strategy”, “long-run competitiveness”, 209
and “governance” is used by sell-side analysts to determine the value of a stock in the
long term. On the contrary, Campbell and Slack (2008) observed that narrative
information in annual reports (including corporate governance and social and
environmental information) was not immediately applicable nor helpful to sell-side
analysts in constructing forecast models and producing written reports to buy-side
analysts. However, this study did not investigate IC information in specific.
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It has been found that buy-side analysts and fund managers need information
that informs decisions making (Barker, 1998). Particularly, they are interested in the
reasons for sell-side analysts’ recommendations and underlying value drivers of the
firms they analyse (Holland, 2006b; Johansson, 2007). As noted by Holland (2006b,
p. 288), this involves a range of qualitative and IC information:
[. . .] the unique private agenda [of fund managers] included information on qualitative,
non-financial company variables such as “quality of management”, strategy and its
coherence, investment and financing plans, recent changes in these and in corporate
succession and management style. Information on competitors and the structure of
competition was very important. Other information sources here included a supportive
company climate for innovation and long-term investment in productive and human assets,
R&D expenditure, flexibility of company to technological change, and the role of internal
financial resources in the above. Customer and suppliers relations were important external
intangibles. Management attitudes to these variables, to profitability, and to return to
shareholders, were also central to this part of the agenda. The categories of private
information identified in the FM [fund manager] cases had many strong similarities to the
ideas outlined by writers in the field of IC.
In an earlier study, Holland (1998) found that an important aspect of one-to-one
meetings (or the informal information agenda) between the company and financial
institutions was a discussion surrounding these types of information. Sell-side analysts
consider the information obtained in this manner as value-added information, which
helps them to provide original analysis and validate and justify their own conclusions
(Johansson, 2007).
In relation to fund managers use of human capital information, Almqvist and
Henningsson (2009) provide interesting insights. They submit that fund mangers see
human capital in a variety of ways, including as a resource, a risk or a non-flexible cost
problem. Particularly, they observed that “creativity of personnel and organisations were
considered very important in both reducing the risk of diminishing cash flows and
increasing the value of firms” (p. 53) and the work environment could negatively affect this.

4.3 Experiment-based literature


There are only a few experimentation studies on capital market participants’ use of
information. Two of these studies examine the impact of IC information on earnings
forecasts and recommendations of sell-side analysts.
JHRCA Thomas (2003) reports on an experiment conducted by PricewaterhouseCoopers. In
14,3 this study, two versions of a corporate annual report and accounts of a company that is
renowned for IC reporting in Denmark (i.e. Coloplast) were given to sell-side analysts.
One version included the original complete set of the corporate annual report and
accounts, including IC reports, while the other version excluded all NFI. The sell-side
analysts were expected to generate an earnings forecast and a recommendation for this
210 company. The results of the experiment revealed that the average revenue and
earnings forecasts of the sell-side analysts, who were not provided with IC information,
were significantly lower than the forecasts of their counterparts, who had IC
information. In addition, the estimates produced by the former group were more widely
spread, and they considered the company as more risky. Moreover, the sell-side
analysts that received the complete set of information were overwhelmingly in favour
of a buy recommendation, while nearly 80 per cent of the group with only financial
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information recommended a sell. The findings indicate that IC information enables


sell-side analysts to assess the quality and sustainability of a company’s current
financial performance. Based on the findings, Thomas (2003, p. 80) argued:
What one can see is that those who generated their models using more complete information
base their estimates upon such things as confidence in the market positioning of the firm, in
the credibility of its strategy and in the strength of the innovation cycle underpinning its new
product pipeline. [. . .] [I]n the absence of any supporting information, the investor is forced to
try to gain reassurance about the quality and sustainability of corporate performance from
the unsubstantiated narratives of the “front end” of the report and accounts and the audited
financial statement itself.
Using a different experimental design, Ghosh and Wu (2007) investigated the relative
utilisation of IC information in making investment recommendations by sell-side
analysts. In this experiment, each analyst was provided with information about four
listed companies in the electronics industry in Taiwan, and either a long-term or a
short-term investment horizon. The four listed companies represented differing
performance levels in terms of financial (i.e. return on investment and earnings growth)
and IC (i.e. the number of information system-related employees as a percentage of
total number of employees and the ratio of R&D to sales) measures compared to their
industry averages. It was found that financial measures are primary variables of
interest to sell-side analysts while IC measures assume a supplementary role. Hence,
this study concluded that IC measures interact with financial measures when
informing sell-side analysts’ investment decisions.
Although not specifically in relation to IC, Coram (2010) and Coram et al. (2009)
investigated the use of non-financial performance indicators in stock price
determination among professional and non-professional investors. He observed that
while negative NFI was factored in stock price determination by both groups of
investors, only professional investors react to positive NFI. In addition, Coram et al.
(2009) found that the use of positive NFI increased with the provision of an assurance
report on that information.

4.4 Verbal protocol analysis-based literature


Verbal protocol analysis has not been used to explore the utilisation of IC information
in particular, but NFI, in general, by sell-side (Coram et al., 2006) and buy-side analysts
and fund managers (Bouwman et al., 1995).
Verbal protocol analysis is a technique to obtain data by asking respondents to IC and the capital
think aloud in a problem-solving situation so that transcripts of verbalised thoughts market
can be recorded on tape. These transcripts, which are referred to as verbal protocols,
can then be analysed to make inferences (Day, 1986). In order to investigate the types
of information mostly used by analysts, the verbal protocols of analysts in their review
of information is transcribed, and subsequently content-analysed to create a list of
frequently mentioned information items (Day, 1986). This method presumes that the 211
more frequently a word or phrase is mentioned, the more important it is. Findings of
this method may differ from that of content analysis of analyst reports, to the extent
that verbal protocols reveal information that is actually used by analysts but may have
not been included in their reports.
The studies reviewed in this paper suggest that analysts place more importance on
financial information than on NFI, but they do actively search for NFI (Bouwman et al.,
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1995; Coram et al., 2006; Day, 1986). An early study employing protocol analysis was
conducted by Day (1986) to explore the usefulness of information contained in annual
reports to investment analysts in their normal review of accounts. She found that while
analysts are mostly interested in accounting information, they actively search
non-accounting items in narrative sections of annual reports.
Bouwman et al. (1995) provide an interesting account of the process of using NFI
(referred to in their study as non-generally applicable accounting principles (GAAP)
information), which could be equally useful in understanding sell-side analysts’
behaviour in similar circumstances. Bouwman et al. found that the use of non-GAAP
information increases when analysts transit from a familiarisation stage (i.e. where
analysts familiarise themselves with the company) to an evaluation stage, and the use
of non-GAAP information is particularly dominant when summarising, analysing and
integrating all acquired information. According to this study, among the non-GAAP
information mostly used by buy-side analysts was information regarding
management’s planned expenditure and descriptive information, such as products,
technology, managers, directors and employees, which comprise IC.

4.5 Content analysis-based literature


Studies employing content analysis have been dominant recently in the examination of
IC information use of sell-side analysts. Flöstrand and Ström (2006) argue that content
analysis of analyst reports provide evidence of valuation relevance of information
items, as analysts only disclose the information that has been helpful for their
valuations. Campbell and Slack (2008, p. 9) argue that:
[. . .] valuation relevance allows for a discussion of factors that may not necessarily have a
direct relationship with the share price but nonetheless may be useful in their overall
valuation process.
Content analytic studies of analyst reports reviewed in this section can be classified
into two groups:
(1) those that investigate NFI in analyst reports, which provide evidence of the use
of IC information; and
(2) those that specifically examine IC information.

The following literature review is structured accordingly.


JHRCA Studies investigating NFI in analyst reports. Content analysis has been commonly
14,3 used by researchers in the investigation of types of information, financial and
non-financial, used by sell-side analysts (Breton and Taffler, 2001; Fogarty and Rogers,
2005; Previts et al., 1994; Rogers, 1996; Rogers and Grant, 1997). These studies reveal
the existence of several types of NFI (including IC information) in analyst reports.
According to Previts et al. (1994), types of NFI disclosed in analyst reports include
212 “market and competition”, “industry and economic conditions”, “history of the
company and its products”, “pricing”, “customers”, “suppliers”, “production
capabilities”, “technologies”, “marketing and distribution systems”, “R&D
expenditure”, “quality of management”, “organisational structure”, “corporate and
management strategy”, “anticipated changes on future earnings”, and “major projects”.
Also, Rogers and Grant (1997) examined six categories of information in analyst
reports:
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(1) financial and operating data;


(2) analysis of financial and operating data;
(3) forward-looking information;
(4) management and shareholder information;
(5) description of company and its products, etc.; and
(6) description of environment in which the company operates.

They observed a substantial amount of NFI in the sample analyst reports with most of
it relating to descriptions about the firm or the environment in which the firm operated.
Fogarty and Rogers (2005) point out that information about the company and
management are given considerable importance in analyst reports. Similarly, Breton
and Taffler (2001) observed that sell-side analysts are concerned with the firm’s
management and strategy, and its trading environment when making recommendation
decisions. They state that “whereas accounting information is of fundamental
importance to sell-side analysts, it is not the only, nor even the most important” (p. 91).
Also, they propose improvements to the provisioning of qualitative information on
management and strategy. Similar conclusions are drawn by Low and Siesfeld (1998),
who argue that sell-side analysts extensively use NFI when evaluating companies and
making recommendations.
On a slightly different focus, Flöstrand and Ström (2006) examined the time
orientation of NFI in analyst reports. They reported that sell-side analysts tend to rely
more heavily on forward-looking NFI than on historical NFI. The mostly reported
non-financial items in this study were “information related to forecasts”, “beneficial or
detrimental circumstances with future cash flows consequences”, “description of
business and industry structure”, and “changes in markets, competition or technology”.
Breton and Taffler (2001) investigated the relationship between types of information
in analyst reports and corresponding recommendations. They found that three NFI
categories (i.e. positive and neutral references to management and strategy, and
negative information cues on market conditions) statistically significantly differ
between types of investment recommendations. Further, the multivariate results of their
study reconfirm the importance of neutral and positive mentions of management and
strategy. These findings indicate that certain types of NFI are more important than some
other types in driving favourable investment recommendations.
Focusing on IC information, Low and Siesfeld (1998) observed the existence of IC and the capital
IC-related information among other non-financial performance information items in market
analyst reports. Also, they submit that IC items, such as “customers and product
related factors”, “structural and employee related factors”, and “innovation related
factors” are used with a greater frequency in analyst reports. Similar conclusions were
drawn in a more recent study conducted by Orens and Lybaert (2007).
On the contrary, Nielsen (2008) found little IC information, as well as social, 213
sustainability and corporate governance information in a sample of fundamental analyst
reports compared to their disclosure by companies. However, he found a substantial
amount of information relating to the “company background (i.e. information on
markets, products, industry and general development of the company)”, “business
segments”, “risks and opportunities”, “value drivers”, and “critical success factors”. Thus,
the low level of IC information in Nielsen’s study could probably be due to the
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narrow operationailsation of the IC concept and limited number of IC items investigated


by him.
Studies investigating IC information in analyst reports. To early 2009, there have
been five content analytic studies specifically investigating IC information in analyst
reports. Table III provides a comparison of findings of these studies in relation to the
frequency of references to the main IC categories examined in them.
Arvidsson (2003), the first to investigate IC information in analyst reports,
examined 105 analyst reports on knowledge-intensive firms in Denmark, Finland,
Norway and Sweden. She used a disclosure index of 81 IC items classified into human,
relational, organisational, R&D and environmental/socio categories. Arvidsson found
that information on R&D is the most referred to IC category followed, respectively, by
relational, human and organisational capital categories.
The next published study of this genre is Garcı́a-Meca (2005). She studied IC
information in 217 analyst reports written on Spanish listed companies. According to
her findings, “strategy”, “technology”, and “processes” are the three most referred to IC
categories, in descending order of frequency. With the exception of “quality and
experience of managers”, human capital is the least referred to IC category in this study.
Extending this work, Garcı́a-Meca and Martı́nez (2007) investigated the disclosure of IC
information in a large sample of analysts’ results reports and company reports.
In contrast to the findings of Garcı́a-Meca (2005), Garcı́a-Meca and Martı́nez (2007)
found that “strategy” was the most referred to IC category followed by “customers”
(Table III). Also, both Garcı́a-Meca (2005) and Garcı́a-Meca and Martı́nez (2007) found
that IC references relating to R&D are rare in analyst reports, a finding that contradicts
Arvidsson’s (2003) results.
The main focus of the study by Flöstrand (2006) was the use of IC indicators (in
contrast to IC references)[11] in analysts’ initiating coverage reports in the USA.
Almost two-thirds of IC indicators found in analyst reports examined in this study
relate to external capital. Number of employees is the only human capital indicator that
was referred to frequently by sell-side analysts, according to the results of this study.
Orens and Lybaert’s (2007) study differs from the other studies listed in Table III, in
that it investigated the relative importance of IC vis-à-vis other NFI. They noted that
sell-side analysts occasionally discuss IC information compared to other types of NFI.
Nonetheless, their results are similar to that of Flöstrand (2006) in relation to the relative
importance placed on external, internal and human capital categories by sell-side analysts.
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Table III.
JHRCA

to main IC categories
Frequency of references
Customers External Human Internal Organisational R&D Strategy Total IC
a
Garcı́a-Meca (2005) 9.5 4.1 27.8 5.1 30.4 13.8
Garcı́a-Meca and Martı́nez (2007)b 25.7 3.7 15.2 3.6 35.2 14.9
Arvidsson (2003)c 22.6 3.1 6.7 31.0 12.2
Flöstrand (2006)d 62.5 10.7 26.8 2.5
Orens and Lybaert (2007)e 40.0 5.0 23.0 21.0
Notes: aFrequency is calculated as the percentage of IC items disclosed over a predefined list of potentially communicable items averaged over the
number of reports in the sample; technology and processes categories are combined together and presented as one category – organisational; bfrequency
is calculated as the percentage of IC items disclosed over a predefined list of potentially communicable items averaged over the number of reports in the
sample; cfrequency is calculated as the percentage of analyst reports referring to an IC category (n ¼ 105); dfrequency is calculated as the number of IC
indicators disclosed per category relative to the number of IC items disclosed for the total sample; frequency for “total IC” is calculated as the number of IC
indicators per analyst report; efrequency is calculated as the percentage of analyst reports referring to an IC category in 2006 analyst reports (n ¼ 40)
The literature reviewed in this section identifies that IC exists to different degrees in IC and the capital
analyst reports. Also, the results are mixed on the importance of IC categories. market
Therefore, it is important to review differences in the use of IC information at IC item
level. Table IV lists the five most and least referred to IC items in each study.
As shown in Table IV, the five most referred to IC items in the listed studies do not
share any common items. However, Garcı́a-Meca and Martı́nez (2007) and Garcı́a-Meca
(2005) find several common IC items in the top five most referred to IC items. These 215
include information relating to investment in new businesses, strategy, new products
and leadership. Also, information on new products is one of the five most disclosed
items in Orens and Lybaert (2007). Similarly, information on acquisitions and brands
are found to be of high importance by Garcı́a-Meca (2005) and Orens and Lybaert
(2007). Further, information relating to supply and distribution channels is considered
to be highly important to sell-side analysts in Orens and Lybaert (2007), Flöstrand
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(2006) and Arvidsson (2003).


Looking at the least important IC items across the studies listed in Table IV, aspects
of employee-related information are commonly found to be the least important.
Further, “career opportunities” and “insurance policies (for employees)” are the least
disclosed IC items according to two studies. However, results are contradictory in
certain instances, where the most referred to IC items according to some studies are
also the least referred IC items according to another study. For instance, “employee
compensation” is a frequently referred to IC item according to Orens and Lybaert
(2007), while Garcı́a-Meca (2005) failed to find any reference to “remuneration systems”
in analyst reports investigated in her study. “Future projects regarding R&D” is
another IC item that is subject to this contradiction. These inconsistent findings could
be due to methodological differences, such as the type of analyst reports investigated
(initiating coverage reports versus recurrent reports, etc.), method of reporting results
(incidence of IC items versus presence of IC items), and differences in item definitions.

5. IC information in IPO prospectuses


More evidence on the importance of IC information in firm valuation can be obtained from
research studies that have investigated IC disclosure in IPO prospectuses. Companies,
through IPO prospectuses, can and will present all information that they think necessary
for potential investors to make an informed investment decision. By having investment
banking firms prepare prospectuses firms ensure that the information needs of the capital
market are addressed. Voluntary disclosure of IC information has been investigated in the
IPO prospectuses of Danish (Bukh et al., 2005), Japanese (Rimmel et al., 2009), Italian
(Cordazzo, 2007) and Singaporean (van der Zhan et al., 2007) companies. These studies
have found a significant level of IC disclosure in IPO prospectuses.
Bukh et al. (2005) investigated the changes in voluntary IC disclosure in IPO
prospectuses in Denmark from 1990 to 2001. They reported an increase in IC disclosure
from 1990 to 1999, while 1999-2001 showed a slight decline. Similarly, van der Zhan
et al. (2007) reported a yearly rise in average IC disclosure in Singaporean IPO
prospectuses from 1997 to 2003. Also, a temporal increase in IC information supplied in
Italian IPO prospectuses was observed by Cordazzo (2007). Rimmel et al. (2009)
replicated the Danish study using Japanese data. They reported that the Japanese IPO
prospectuses disclose less IC than the Danish ones, but the emphasis on the main IC
categories was similar between the two countries.
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14,3

216

Table IV.
JHRCA

disclosure studies
IC items in prior IC
Most and least reported
Most referred to IC items Least referred to IC items

Arvidsson (2003) Status of product portfolio Objectives and reasons for investments in IT
Competitive strength of R&D activities in relation to Corporate quality performance
competitors Organisational flexibility and adaptability
Future prospects regarding R&D Abilities of employees
Network of suppliers and distributors Mention of directors of top management team
R&D projects by position in pre-clinical stage Social responsibility
Investment in new business
Garcı́a-Meca (2005) Business vision, objectives and consistency of External and internal failures
strategy Remuneration systems
New products and technology Dependence on key employees
Acquisitions Career opportunities and insurance policies (for
Leadership and brands employees)
Garcı́a-Meca and Martı́nez (2007) Investment in new business Future projects on innovation and R&D
Credibility and consistency of strategy Patents pending
New products Career opportunities
Strategic alliances and agreements Insurance policies (for employees)
Leadership and trademarks Job rotation opportunities, dependence on key
employees, value added per employee, career
opportunities, and social responsibility
Orens and Lybaert (2007) (only from IC items Realised acquisitions Education and training programs of employees
included in the study for the 2002 sample) Evolutions in the market share Staff policy
Innovation (e.g. new products and production Employee satisfaction
processes) Organisation structure
Distribution and delivery methods Customer satisfaction and loyalty
Main brands of the company
Employee compensation
Note: Flöstrand’s (2006) study is excluded from this comparison as it concerns IC indicators only
It was found that information on strategies and customers are the most reported types IC and the capital
of IC in the Danish and Japanese IPO prospectuses. Also, “strategy” was found to be market
the most disclosed IC attribute in the Italian IPO prospectuses (Cordazzo, 2007). In
contrast, van der Zhan et al. (2007) found “HRM” as the mostly disclosed IC category
followed by information relating to strategy in the Singaporean IPO prospectuses.
Further, the relative popularity of other IC categories differed among the four studies.
The studies reviewed here indicate that companies actively disclose IC information 217
in IPO prospectuses, and the extent of disclosure has increased over time. Since IPO
prospectuses are expected to provide the types of information that capital market
participants find important, the emphasis on IC can be interpreted as an indication of
its importance to the capital market.

6. Summary and future research directions


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The purpose of this paper was to review and synthesise the research literature on the
importance of IC to the capital market. Capital markets research literature reveals that
a variety of IC items are associated with the market value of equity and financial
performance. Nonetheless, such studies are unable to provide a complete
understanding of the importance of many other types of IC to the capital market
due to the inability to measure most types of IC. In particular, it was observed that
there is a dearth of research on the value-relevance and predictive ability of internal
capital-related information and human capital information other than that relating to
the top management. It is difficult to find measurement proxies for these aspects of IC
although they may be important from a capital markets perspective.
A more suitable approach is to investigate the types of IC information is considered
useful/important by capital market actors, such as financial analysts and fund
managers, and how they use IC information in their assessment of firm value.
A number of studies were found to have taken this approach and used questionnaire
surveys, face-to-face interviews, experimentations and verbal protocol analysis to
gather data. Although most of them have not specifically investigated IC information
in particular, valuable insights on the usefulness/importance of types of IC to capital
market participants could be obtained from them. In particular, it was found that most
NFI used by capital market actors shows characteristics of IC and IC information plays
an important role in financial analysts’ and fund managers’ decision-making processes
together with other information. Further, the utility of IC information was found to be
greatest when predicting firm value in the long term. Also, it was found that the
availability of IC information significantly improves analysts’ earnings forecasts and
reduced their risk estimates for firms.
Researchers have also analysed the content of analyst reports written by sell-side
analysts in order to understand the types of IC that is important to analysts, and as a
result communicated by them to the readers of their reports. However, much variation
exists in the results of these studies in relation to the importance placed by analysts on
various IC items albeit there is some agreement in relation to the importance of main IC
categories. Also, evidence from IC disclosure studies on IPO prospectuses sheds light
on perceived importance of types of IC information to the capital market.
Based on the review of literature, we find a number of opportunities for future IC
research. First, future research could investigate whether the importance placed on
types of IC information differs by industry or sector in order to determine the most
JHRCA appropriate IC reporting package by industry. Second, although interviews-based
14,3 studies reveal that financial analysts’ use of IC information differs by the investment
horizon considered, to our knowledge, there are no studies investigating the impact of
the investment horizon on the types of IC information used by capital market
participants. Third, there is a scope for case study-based research, preferably using
mixed methods, in order to obtain an in-depth understanding of the importance of IC
218 information in company analysis. Fourth, research of the genre of content analysis of
analysts’ reports can be extended to investigate longitudinal changes in the use of IC
information in analyst reports in a bid to examine the chronological evolution of
reliance on IC information.
Fifth, there are differences between the IC information found in analyst reports and
those IC information sell-side analysts claimed to be important as per survey and
interview-based studies. Future research could examine this gap with a view to
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exploring analysts’ private information agenda, as noted by Holland (1998). Lastly, the
experimentation method can be used to explore the impact of various types of IC items
(or groupings of IC, such as external, internal and human capital) on financial analysts’
assessments of stock prices, earnings forecast and firms’ beta risk. As existing
experiment-based studies have only considered IC as a collective, this is an interesting
point of departure in search of greater insight.

Notes
1. Although Collins et al. (1997) and Francis and Schipper (1999) found that the explanatory
power of book value of equity in relation to security prices/returns has increased over time,
Brown et al. (1999) reveal econometrical problems associated with regressions in these
studies. They indicate that the R 2 in regressions used by Collins et al. (1997) and Francis and
Schipper (1999) is positively correlated with the cross-sectional coefficient of variation of the
scale factor. They argue that when corrected for this the results of the two studies are
reversed, actually indicating a decline in value-relevance, over the four decades considered.
2. IC is a nebulous concept and is variously defined and interpreted. The common themes
underlying the numerous definitions of IC are that it is intangible in nature, economic
benefits embodied in IC accrue over the long term and it is directly and indirectly linked to
future firm value (Abeysekera, 2006; Edvinsson and Malone, 1997; Edvinsson and Sullivan,
1996; Kaufmann and Schneider, 2004; Rastogi, 2003). It is commonly held that IC comprises
relational (external), structural (internal) and human capital. External capital can be
explained as all resources linked to a firm’s relationship with external stakeholder including
suppliers, customers, partners, government and the community plus the perceptions held
about the firm by these stakeholders that can benefit the firm. Similarly, internal capital
comprises intellectual property and the intangible infrastructure that a firm has developed
internally or bought in, which enable a firm to be productive, efficient, effective, flexible and
innovative. Human capital consists of the knowledge, skills, attitudes, abilities, competences,
and qualities of a firm’s employees as well as the mechanisms that enable, support and
motivate their performance, such as training and development, employee benefits and
compensation schemes and a favourable working environment.
3. Innovative capital is defined as the sum of the unamortised past R&D expenditures that are
expected to generate current and future earnings (Lev and Sougiannis, 1999).
4. NFI may be defined as all information disclosed outside the financial statements and related
notes issued by a company (Orens and Lybaert, 2007; Robb et al., 2001).
5. Ashton (2005) identifies about 200 studies that investigate the association between IC and the capital
intangible value drivers and financial outcomes at both firm and market levels. These
studies are grouped under human, customer, process, and renewal and development market
categorised as per the Skandia Business Navigator (Skandia, 1994).
6. Holthausen and Watts (2001) classify “association studies” into two categories: (1) relative
association studies that investigate the association between stock market values or changes
in those values (over long windows) and accounting numbers and (2) incremental association 219
studies that investigate whether a particular accounting number of interest is able to explain
the stock market values or changes in those values (over long windows) among other
variables (examine whether the estimated regression coefficient of the particular accounting
variable is significant).
7. AASB1011 – Accounting for Research and Development Costs was superseded by AASB
138 – Intangible Assets that came into effect from 1 January 2005.
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8. This index is a national economic indicator of customer satisfaction managed by the


National Quality Research Centre at the University of Michigan Business School and the
American Society for Quality (Ittner and Larker, 1998).
9. POPS is a measure of growth potential based on population size. It is the total population
area a firm is licensed to operate multiplied by the firm’s share of ownership.
10. Ashton (2005) identifies about 200 studies that investigate the association between
intangible value drivers and financial outcomes at both firm and market levels. These
studies are grouped under human, customer, process, and renewal and development
categorised as per the Skandia Business Navigator (Skandia, 1994).
11. Flöstrand (2006, pp. 463-4) defines an IC indicator as “[. . .] a parameter or a value derived
from parameters, which provides information about a phenomenon. The indicator has
significance that extends beyond the properties directly associated with the parameter
values”. IC indicators are purely numerical or monetary representations of IC.

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Corresponding author
Subhash Abhayawansa can be contacted at: sabhayawansa@swin.edu.au

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