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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.
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.
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.
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
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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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
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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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.
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.
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.
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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214
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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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.
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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Corresponding author
Subhash Abhayawansa can be contacted at: sabhayawansa@swin.edu.au
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