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Keywords:
Human capital
Human asset
Intellectual capital
Compensation expense
Value relevance
a b s t r a c t
We examine the valuation implications of human capital both for a broad sample of rms and for subsamples
of high-technology rms and low-technology rms. Our results suggest that the market appears to value
compensation expenses not as expenses but as if they serve as a proxy for a human asset that is omitted from
the balance sheets. The ndings are consistent with human capital comprising a more sizable portion of the
value of high-technology rms than of low-technology rms. The ndings also indicate that compensation
expenses are valued differently from other expense components of income. Markedly, despite critical
differences between investors on the exchange and those buying shares in transactions outside the exchange
(controlling interests, information asymmetry, etc.), their assessment of the enhanced value of a rm
attributable to human capital is shown to be relatively similar. The results in this study are consistent with
compensation expenses creating a valuable intangible asset, hence suggesting that reform in the accounting
treatment of these expenses is of critical importance.
2009 Elsevier Ltd. All rights reserved.
1. Introduction
Human capital comprises a sizable portion of the asset base of
companies in the 21st century knowledge economy. The changing
economy, in which there is a growing number of knowledge-based
emerging industries, triggers a need to comprehend the asset base of
companies, and how these assets contribute to value creation. A critical
aspect of that understanding is the ability to quantify the value of
intangibles. A large empirical literature provides ample evidence of the
growing importance of intangible assets (e.g., Lev, 2005) and intellectual
capital (e.g. Edvinsson & Malone, 1997) in the new, knowledge-based
economy, and the inadequacy of the existing accounting methods for
managing and measuring the value of those assets (e.g., Stewart, 1997;
Lev & Zarowin, 1999; Brown, Kim, & Lys, 1999; Francis & Schipper, 1999;
Core, Guay, & Van Buskirk, 2003).
In this study, we focus on the human aspect of the intangibles that
drive the value created by a company. Specically, we investigate the
market's assessment of human capital and the affect that this
assessment has on rm value. We inquire whether investors view
human asset-related expenses (compensation expenses) differently
from other expenses included in the rm's income statement. Generally
Accepted Accounting Principles (GAAP) mandate the immediate and
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Swartz et al. (2006) assert that intellectual capital is omitted from the specication
of the Ohlson (1995) valuation model employed in value relevance studies. They thus
include an intellectual capital variable in the Ohlson (1995) valuation model, and nd
that it signicantly contributes to the explanation of share prices.
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et al., 2003; Hand & Landsman, 1998; Swartz et al., 2006). We set
proxies for expected growth to zero when their values are missing
(e.g., Core et al., 2003; Morck et al., 1988).8
Markedly, extant value relevance research neglects to include
another prominent value driver human capital which has been
shown in the literature to have an increasing importance to a rm's
overall value. We thus add to the regression a proxy for human assetrelated expenditures, CompPr:
MV = 0 + 1 BV + 2 AbE + 3 NegAbE + 4 R&D + 5 CapEx
+ 7 SalesGr + 8 Div + 9 CompPr +
8
Inferences remain the same when observations with missing values are extracted
from the analysis.
I. Gavious, M. Russ / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 165173
169
Table 1
Descriptive statistics.
Pooled sample
TV
MV
BV
TV/BV
MV/BV
AbE/BV
High-technology
Low-technology
Mean
Median
S.D.
Mean
Median
S.D.
Mean
Median
S.D.
1146
773
298
7.702
5.289
0.513
184
123
62
2.870
1.833
0.066
5123
3588
1222
88.356
67.733
7.217
1148
804
235
11.635
8.829
0.964
168
116
47
3.530
2.334
0.133
4953
3713
1009
135.467
106.814
11.319
1145
753
338
5.215
3.052
0.228
199
126
74
2.580
1.641
0.043
5230
3507
1338
33.629
16.311
1.965
This table reports the descriptive statistics for our sample of 3186 (1234 high-technology and 1952 low-technology) rms. Variable denitions: TV is transaction value measured as
the amount paid by a buyer for the target rm's equity in a transaction outside the exchange; MV is market value of common shares outstanding measured based on target stock price
one week prior to the original announcement of the transaction; BV is book value of common equity as of scal year-end; AbE is abnormal earnings measured as net income before
extraordinary items and discontinued operations, minus 0.12 BVt 1.
13
5. Results
Tables 3 and 4 present the results from estimating valuation
Eqs. (1) and (2), respectively, with expected rate of return on book
value of equity, r, set at 12%. We perform the sensitivity analyses for
our results with different estimates of r; rst, we employ different
rates of return in the range of 1014% and second, we employ r
derived from the rms' PE ratio. The results obtained (untabulated)
are qualitatively similar to those presented in the tables, indicating
that our ndings are robust to the approach applied for estimating r.
Table 3 reveals that the signs of the estimated coefcients in the
full sample regression are consistent with prior research and are statistically signicant. The coefcient on book value of equity (1.357,
p: 0.000) signicantly exceeds 1. The Ohlson (1995) model predicts that
the book value of equity coefcient should equal 1, however the model
does not account for accounting conservatism which results in
systematic understatement of equity book value and, hence, systematic
overstatement of its valuation coefcient (Bell et al., 2002; p. 984). This
overstatement is even more pronounced in high-technology industries
than in low-technology. The coefcient on abnormal earnings in prot
years is signicantly positive (8.203, p = 0.000) and the coefcient on
abnormal earnings in loss years is insignicantly negative (sum of
coefcients on AbE and NegAbE, 0.154, p = 0.367).15 This nding
suggests that after controlling for other explanatory variables, investors
expect that a current ability to generate positive abnormal earnings
precedes higher future cash ows. On the other hand, negative abnormal earnings are value-irrelevant; in this case, investors form their
expectations for the future based on alternative proxies for future
earnings (or cash ow) growth. When we run the regression for rms
with negative abnormal earnings only, we observe signicant changes
in two coefcients on proxies for future earnings growth; the coefcient
on sales growth as well as its signicance increase (0.676, p = 0.000)
whereas the coefcient on dividends loses its signicance (0.791,
p = 0.300). This result implies that the ability to generate higher sales
becomes more crucial in the market's assessment of a rm's future
performance when the rm fails to generate current abnormal earnings.
On the other hand, dividends are irrelevant as such rms generally avoid
paying dividends.
For the high-technology and low-technology subsamples, we nd
the coefcients are all of the same sign as those in the full sample.
Additionally, all coefcients are statistically signicant with the exception of sales growth in low-technology rms. A possible explanation for
the difference in the value relevance of sales for high-technology and
15
Prior studies that use reported earnings rather than abnormal earnings in their
specications document a negative coefcient on earnings in loss years (see, for
example, Core et al., 2003). When we run our regressions substituting abnormal with
reported earnings, we obtain a negative coefcient on negative earnings, consistent
with prior research.
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Table 2
Pearson correlations among variables: transaction value, market value, abnormal earnings, R&D, capital expenditures, sales growth, dividends, and proxy for compensation expenses.
Variable
TV
MV
BV
AbE
R&D
CapEx
1.000
0.522
0.479
0.158
0.227
0.145
0.280
0.347
1.000
0.105
0.005
0.279
0.168
0.391
0.528
1.000
0.078
0.000
0.165
0.077
0.011
1.000
0.156
0.060
0.028
0.071
1.000
0.119
0.153
0.222
1.000
0.139
0.128
0.316
0.098
0.228
0.671
1.000
0.097
0.087
0.091
0.156
0.065
1.000
0.217
0. 109
0.031
0.075
1.000
0.136
0.058
0.250
0.151
0.396
0.467
1.000
0.005
0.020
0.180
0.040
0.033
1.000
0.095
0.045
0.019
0.084
SalesGr
Div
CompPr
1.000
0.046
0.262
1.000
0.148
1.000
1.000
0.091
0.085
0.321
1.000
0.025
0.269
1.000
0.208
1.000
1.000
0.111
0.150
0.184
1.000
0.032
0.170
1.000
0.094
1.000
TV, MV, BV, and AbE are as dened in Table 1. R&D is abnormal earnings measured as net income before extraordinary items and discontinued operations, minus 0.12 BVt 1; R&D
is research and development expenditures; CapEx is capital expenditures; SalesGr is annual change in sales; Div is cash dividends; and CompPr is a proxy for compensation expenses
estimated as SG&A expenses, minus advertizing and R&D expenses (if included in SG&A). , , and indicate signicance levels of 10%, 5%, and 1%, respectively.
Constant
BV
AbE
NegAbE
R&D
CapEx
SalesGr
Div
Adj. R2
# of obs.
All rms
High-technology rms
Low-technology rms
2.401
(0.000)
1.357
(0.000)
8.203
(0.000)
8.357
(0.000)
4.724
(0.000)
0.519
(0.000)
0.296
(0.021)
1.379
(0.031)
0.745
3186
5.075
(0.005)
1.718
(0.000)
10.078
(0.000)
10.143
(0.000)
2.948
(0.004)
0.887
(0.000)
2.052
(0.000)
6.852
(0.001)
0.729
1234
1.902
(0.000)
1.296
(0.000)
7.692
(0.000)
7.097
(0.000)
2.503
(0.023)
0.464
(0.000)
0.106
(0.384)
1.555
(0.009)
0.755
1952
See Tables 1 and 2 for denitions of all variables. NegAbE is AbE if AbE 0, 0 otherwise.
Estimates for all equations are in per-share form with intercepts suppressed. The
regressor Constant is the inverse of number of shares outstanding at scal year-end
(included in the scaled model to estimate the intercept for the corresponding unscaled
model). P-values are in parentheses.
I. Gavious, M. Russ / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 165173
Table 4
Market value regressions including a proxy for compensation expense.
Constant
BV
AbE
NegAbE
R&D
CapEx
SalesGr
Div
CompPr
Adj. R2
# of obs.
All rms
High-technology rms
Low-technology rms
2.163
(0.000)
1.425
(0.000)
8.460
(0.000)
8.324
(0.000)
4.681
(0.000)
0.518
(0.000)
0.394
(0.003)
1.109
(0.085)
0.988
(0.000)
0.866
3186
4.284
(0.026)
1.790
(0.000)
10.289
(0.000)
10.386
(0.000)
2.470
(0.004)
0.993
(0.000)
2.026
(0.000)
7.065
(0.001)
1.884
(0.001)
0.858
1234
1.814
(0.000)
1.322
(0.000)
7.625
(0.000)
7.028
(0.000)
3.006
(0.021)
0.440
(0.000)
0.150
(0.234)
1.401
(0.021)
0.395
(0.001)
0.877
1952
See Tables 1 and 2 for denitions of all variables. Estimates for all equations are in per-share
form with intercepts suppressed. The regressor Constant is the inverse of number of
shares outstanding at scal year-end (included in the scaled model to estimate the
intercept for the corresponding unscaled model). P-values are in parentheses.
171
Table 5
Transaction value regressions excluding a proxy for compensation expense.
Constant
BV
AbE
NegAbE
R&D
CapEx
SalesGr
Div
Adj. R2
# of obs.
All rms
High-technology rms
Low-technology rms
1.584
(0.317)
2.044
(0.000)
12.870
(0.000)
13.095
(0.000)
5.748
(0.000)
1.421
(0.000)
0.733
(0.000)
4.401
(0.000)
0.785
3,186
0.221
(0.933)
2.473
(0.000)
13.977
(0.000)
14.238
(0.000)
3.573
(0.005)
1.667
(0.000)
3.861
(0.000)
8.164
(0.008)
0.749
1,234
3.004
(0.122)
1.970
(0.000)
12.505
(0.000)
12.345
(0.000)
2.175
(0.296)
1.343
(0.000)
0.323
(0.099)
4.979
(0.000)
0.801
1,952
See Tables 1 and 2 for denitions of all variables. Estimates for all equations are in per-share
form with intercepts suppressed. The regressor Constant is the inverse of number of
shares outstanding at scal year-end (included in the scaled model to estimate the
intercept for the corresponding unscaled model). P-values are in parentheses.
with the same sign, however larger, possibly because the sale price
includes in it a control premium that is not priced on the exchange. One
exception is the coefcient on R&D in low-technology rms, which is
smaller (larger) in the regression of transaction (market) values.
Table 6 shows that 9 is positive and highly signicant in the full
sample regression as well as in the subsamples. Again, 9 is signicantly
larger (smaller) for high (low)-technology rms. In the full sample, 9 is
1.315 compared with 0.988 in the market value regression. For high
(low)-technology rms, 9 is 2.309 (0.605) compared with 1.884
(0.395) in the market value regression. The results are robust to cost of
capital estimating approach. Thus, each dollar that a rm spends on its
employees whether a high-technology or low-technology is worth
more in the eyes of a buyer outside the exchange because this buyer is
about to control the rm and thus will directly be affected by the quality
and the interests of its employees. Indeed, the transaction value regressions have a higher power of explanation than the market
regressions. The addition of a proxy for compensation expense to the
Table 6
Transaction value regressions including a proxy for compensation expense.
Constant
BV
AbE
NegAbE
R&D
CapEx
SalesGr
Div
CompPr
Adj. R2
# of obs.
All rms
High-technology rms
Low-technology rms
1.080
(0.510)
2.046
(0.000)
12.676
(0.000)
12.863
(0.000)
5.686
(0.000)
1.392
(0.000)
0.741
(0.000)
4.284
(0.000)
1.315
(0.005)
0.916
3186
0.994
(0.723)
2.538
(0.000)
14.233
(0.000)
14.542
(0.000)
3.522
(0.006)
1.828
(0.000)
3.829
(0.000)
8.366
(0.006)
2.309
(0.002)
0.886
1234
2.625
(0.200)
1.902
(0.000)
12.013
(0.000)
11.708
(0.000)
1.635
(0.434)
1.279
(0.000)
0.211
(0.297)
5.153
(0.000)
0.605
(0.003)
0.937
1952
See Tables 1 and 2 for denitions of all variables. Estimates for all equations are in per-share
form with intercepts suppressed. The regressor Constant is the inverse of number of
shares outstanding at scal year-end (included in the scaled model to estimate the
intercept for the corresponding unscaled model). P-values are in parentheses.
172
I. Gavious, M. Russ / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 165173
should be higher (lower), since life of knowledge (e.g. Russ & Jones,
2008) and product life cycles (e.g. Gardner, Johnson, Lee, & Wilkinson,
2000) in the former are shorter.
Lastly, Schmidt and Dharan (2004) offered a typology of intellectual
assets' exploratory models while recommending moving human capital
valuation studies toward a more rigorous approach to research. Within
their framework, our study would be identied as an association model,
which is the rst step in understanding the phenomenon. We join their
call for a need to move the research of human capital valuation towards
models that are more detailed and descriptive, and as such would
provide more managerial insights in regard to creating and managing
human assets more effectively and efciently.
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