AARHUS UNIVERSITY

BUSINESS AND SOCIAL SCIENCE

DEPARTMENT OF ECONOMICS AND BUSINESS ECONOMICS

Intangible assets, firm performance and value creation

An empirical study of German public limited companies

Author:
Raissa Kanjo Mantoh
(Studentnr. 201302214)
Academic supervisor:
Stefan Hirth
Associate Professor
Department of Economics and Business Economics
1st September 2015

ABSTRACT
Researchers and practitioners have reached a general consensus that intangible assets play a
vital role in the success and survival of firms in todays knowledge economy. The primary
purpose of this paper is to investigate empirically the contribution of intangible assets to
value creation and performance of firms.
Evidence was obtained using German public limited companies. Primarily, Orbis (Bureau
van Dijk) and COMPUSTAT GLOBAL databases were the source of audited financial
statements data on 189 German companies from 2009 to 2013. This study makes use of
VAIC TM (Value Added Intellectual Capital) and CIV (Calculated Intangible Value) as
measures of the efficiency and value of intangible assets. It applies multiple regressions and
correlation analysis to examine the influence of intangible assets on selected traditional
financial performance measures.
The use of VAIC TM and CIV is due to the fact that evidence have been found suggesting
that financial statement do not account for the full value of intangible assets. The role of
balance sheet recorded intangible assets in value creation is also examined in this paper.
Empirical findings show that the CIV is a major player in the value creation process. The
contribution of intangible assets to the market value of firms is explained by accounting
value of intangible assets to an extent, but a fuller picture is obtained with the use of the CIV.
The capital employed and human capital efficiency components of the VAIC together,
contribute to the profitability and productivity of firms. Structural capital efficiency had no
effect on the financial measures.
Intangible assets do contribute to value creation and performance of firms. However, further
research and developments are needed in the measurement and accounting of intangibles.

Contents
1. INTRODUCTION TO THESIS .................................................................................................. 5
1.1 Introduction ............................................................................................................................ 5
1.2 Research question ................................................................................................................... 6
2. BACKGROUND AND LITERATURE REVIEW .................................................................... 8
2.1 Brief history ............................................................................................................................ 8
2.2 Concept of intangible assets................................................................................................... 8
2.3 Why measure intangibles?..................................................................................................... 9
2.4 Measurement of intangibles ................................................................................................ 11
2.5 Germany and Intellectual capital ....................................................................................... 15
2.6 Intangible assets and value creation ................................................................................... 17
2.7 Intangible assets and performance ..................................................................................... 21
2.8 Advantages and shortcomings of models employed .......................................................... 23
3. RESEARCH METHODOLOGY .............................................................................................. 26
3.1 Conceptual framework of models employed and research hypothesis ............................ 26
3.2 Data and sample selection.................................................................................................. 30
3.3 Data analysis ......................................................................................................................... 33
4. EMPIRICAL RESULTS UNDER VAIC FRAMEWORK .................................................... 36
5. EMPIRICAL RESULTS UNDER CIV FRAMEWORK ....................................................... 41
6. ADDITIONAL ANALYSIS OF MARKET VALUATION USING MARKET
CAPITALIZATION....................................................................................................................... 42
7.

DISCUSSION.......................................................................................................................... 45

8.

CONCLUSION ....................................................................................................................... 48

REFERENCES ............................................................................................................................... 49

LIST OF TABLES
Table 1 Market Values of well-known companies consist more of intangible than tangible
assets
Table 2 Classification scheme of intellectual capital.
Table I Sample distribution by industry
Table II Comparing sample used in different research papers
Table III Descriptive statistics of selected variables
Table IV CIV model sample distribution by industry
Table V R&D intensity
Table VI Correlation analysis of the full sample
Table VII Correlation with M/B ratio across different samples
Table VIII regression results for M/B value ratio
Table IX Correlation with ROE across different samples
Table X Regression of ROE across different samples
Table XI Regression results for profitability and productivity models
Table XII Correlation with ROA across different samples
Table XIII Correlation with EP and GR
Table XIV Effect of current and future VAIC and HCE on EP
Table XV Correlation analysis of regression variables under the CIV framework
Table XVI Regression analysis for models under the CIV framework
Table XVII Correlation of VI and VT with performance measures.
Table XVIII Correlation analysis - MCAP models
Table XIX Regression results for MCAP

LIST OF FIGURES
Figure 1. Average Price-to-Book ratio of the S&P 500 companies.
Figure 2: Investment in intangible assets by sector, 1995-2006
Figure 3. Classification of common success factors

1. INTRODUCTION TO THESIS
1.1 Introduction
In the last few decades, focus has shifted from the traditional financial statement source of
value and transformation like tangible assets to intangible assets like innovation, knowledge,
and intellectual property. In the 1996 Organization for Economic Corporation and
Development (OECD) publication, it referred to its members as knowledge-based
economies due to the trend towards high-technology investments and industries, more highly
skilled labour and related productivity gains. In the United Kingdom (UK) businesses in
2011 had a 137.5 billion investment in intangible assets, 20% more compared to tangibles
(89.8 billion)1.
Traditional accounting is unable to keep up with this new kind of businesses and economies.
The quality of information available on a firms financial statement is of importance to
investors and other market participants in determining the market value of a firm. Lev and
Zarowin 1999 when investigating the usefulness of financial information to investors in
comparison to the all the information available in the market place found evidence that
measures like reported earnings, cash flows and book equity values were deteriorating in
importance and usefulness in this respect. Large investments in intangibles like research and
development, which drive change and value creation, where not properly accounted for in
financial statements as the expenses were recorded but benefits where not matched to
expenses in the same year. Because of the mismatching of cost and benefit, the accounting
system failed to fully reflect firm value and performance.
The shortcoming of traditional accounting is evident in its inability to explain the Marketto-Book (M/B) value gap. Lev 2001 research on S&P (Standard and Poors) 500 companies
M/B ratio shows this discrepancy (value gap) in Figure 1. It shows that most of firm market
value is not reflected in financial statements.

UK Government website
(https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/312034/ipresearchintangible-summary.pdf) retrieved 23/03/2015.

Figure 1. Average Price-to-Book ratio of the S&P 500 companies.

Lev identified the absence of proper IA accounting as the source of this gap and the the
reason for growing attention on IA. Researchers agree that the future of organizations depend
on their knowledge and intellectual capital. Therefore the identification, management,
estimation and disclosure of intangible assets (IA) is the key to firm value (Edvinsson,
Malone, 1997). Edvinsson and Malone (1997) define the difference between a firms market
value and book value as the value of intellectual capital.

1.2 Research question

This paper will not try to come up with a model for measuring IA for financial statement
purposes. It will focus instead on IA contribution to financial performance and value of
companies using information from traditional statements and models already in use today.
Intellectual capital and intangible assets will be used interchangeably.
In most of the financial statements used in this paper, when talking about nonfinancial
performance indicators, the firms highlight employee number and remuneration, educational
qualifications, on the job training and lifelong learning and research and development which
are all IA. In reference to Lev and Zarowin 1999s criticism regarding mismatch of cost
and benefits, by using financial statements covering a 5 year period, both expense and
benefits attributed to intangibles will be captured to some extent.
Pulic (2000) measured the efficiency of value added by capital employed and intellectual
capital using Value Added Intellectual Coefficient (VAIC TM). I will employ Chen et al.
(2005) use of VAIC (as a measure of intellectual capital) to investigate the relationship
between intellectual capital and a firms M/B value ratio and financial performance.
To investigate the role of IA as a whole in the creation of market value, I will replicate the
work of Volkov and Garanina (2008). They examined the impact (explanatory power) of
tangible and intangible assets on the market value of company asset using Calculated
Intangible Value (CIV) method proposed by Thomas Stewart in 1995, by running a series of
regression of IA and tangible assets on market value. The independent variables are
estimated using CIV based on Residual Operating Income (REOI) model.
The following questions will be answered;
1 .a. Do companies with greater VAIC and CIV have better firm performance: market
valuation, profitability and productivity?
b. To what degree does the CIV explain the market value of the companys assets?

VAIC is made up of human capital efficiency (HCE), structural capital efficiency (SCE)
and physical capital or capital employed efficiency (CCE).
2. a. Do companies with greater physical capital have better firm performance; market
valuation, profitability and productivity?
b. Do companies with greater structural capital efficiency have higher M/B ratios, better
firm performance; market valuation, profitability and productivity?

c. Do companies with greater human capital efficiency have better firm performance;
market valuation, profitability and productivity?
Chen, Cheng, & Hwan (2005) argue VAICs SCE does not capture two important
components of structural capital; innovative capital and relational capital. Using Research
and Development (R&D) and advertisement spending as proxies, they investigate if it
captures additional information on SCE. Chauvin and Hirschey (1993) found evidence that
advertising and R&D expenditures consistently had a large, and positive influence on
corporate market value.
3. After controlling for the structural capital efficiency of VAIC, do companies with greater
R&D have better firm performance; market valuation, profitability and productivity?
4. Are balance sheet recorded intangible assets of value relevance?

2. BACKGROUND AND LITERATURE REVIEW

2.1 Brief history
In the late 1960s to early 1970s interest in IA gained popularity with Human Resource
Accounting (HRA). HRA was defined as the process by which effective management within
an in an organization could be facilitated by identifying, measuring, and communicating
information on human resource. Employees were seen as assets and the accounting principle
of matching benefits to cost were used. Interest in HRA slowed down in the early 1980s but
gained back momentum from the late 1980s throughout the 1990s. The development of case
studies to describe the application of HRA principles within organisations began in 1980s,
sweeping across different industries to the extent that professional baseball teams used them
to allocate value to their talent (Phillips 2002).
One of the notable early contributors to the intellectual capital movement was Hiroyuki Itami
in his work Mobilizing Invisible Assets published in Japanese in 1980. It examined the
impact of invisible assets on management in Japanese companies and provided insight on
IA and its importance to corporations by emphasising that successful corporate strategies
depended upon the rallying of a firms intangibles (Sullivan 2000).
Two other major contributors are Karl-Erik Sveiby and Thomas Stewart. Sveiby published
The Know-How Company in 1986 on managing IA, The Invisible Balance Sheet in
1989 and, in the fall of 1990 Knowledge Management. The term Intellectual Capital
was coined in 1990 in Stewarts presence and in 1991 he introduced the idea that IA had a
lot to do with profitability and success of organisations. Years on, many articles and book
have been written on the subject of intellectual capital in an attempt to understand, measure,
use and manage intellectual capital (Sullivan 2000, Phillips 2002).

2.2 Concept of intangible assets

There is no universally accepted definition of intangible assets. However, there are some
characteristics which most definitions have in common. IA are non-physical, potential
sources of future economic gain and, to some degree retainable and tradable. IA includes
Research and Development (R&D, expensed or capitalised), patents, trademarks, human
resources and capabilities, organisation competencies (like database and technology), and
relational capital (e.g. customer and supplier networks, organisational design and process)
(OECD 2006).
The definition of IA includes components beyond the traditional intangible assets like patent,
trademark and goodwill. Lev and Daum (2004) give two reasons for this. First, on a standalone basis, intangibles are inert, they can neither create value nor generate growth and need
to be combined with other production factors to do so. Secondly, the components of
intangibles are intertwined making them difficult to isolate and quantify. For instance,
goodwill has organizational design and process, R&D and expertise of workforce as its
sources.

The common characteristic among assets be it physical, financial or intangible is that it is a

claim to future benefits. Intangible assets are similar to other assets in this regards.
Besides their non-physical nature, another characteristics that differentiates intangibles from
other assets is their non-tradability. Most intangibles are not traded in an active and
transparent market. When goodwill is traded, detailed information is usually not available to
the public. Information asymmetries often exist between owners and outsiders.
Comparables/multiples (observed values or prices), which are used by most valuation
methods are difficult to come by.
A functioning market has certain characteristics like, numerous buyers and sellers, informed
participants concerning the available opportunities to trade and the characteristics of the
object of trade, lastly contractual agreements must be feasible and at relatively low cost. For
standard commodities like wheat and coal, these characteristics are easily met. This is not
always the case for some intangibles. The characteristics of the traded item like the size may
not be easy to quantify. Sellers are reluctant to disclose all the details of know-how when
there is absence of legislation protecting them. The need to protect know-how also makes it
difficult for buyers to be aware of opportunities (Leadbeater 1999). Lack of a common
framework and rules governing contractual agreements makes entering into contracts a
costly process. All these combined results in non-tradability of intangible assets, making
them a risky investment for investors and managers (Lev 2005).
Huge attention is being given to intellectual capital intangibles in spite of their perplexing
nature. Lev (2005) cited two major economic trends as the rationale for enormous attention
given to: globalization and commoditization of physical assets. In the early days, owning
physical assets like automated assembly lines provided a competitive edge to the owners.
Commoditization means all competitors now have access to physical assets therefore they
are now no longer a competitive advantage. Increased competition is the outcome of
globalization. Survival especially in some economic sectors requires innovation created
primarily using intangible investment Intangibles like patents are unique to firms and
provides a way to gain competitive advantage.

2.3 Why measure intangibles?

In the mounting literature on IA, different researchers have come up with non-identical and
sometimes conflicting logic as to why organisations should take up measuring their IA.
These differing opinions can easily lead to confusion about the why. To make sense of it all,
Marr et al. (2003) carried out a systematic review, a detailed and replicable review of both
published and unpublished studies of intangible assets. The aim was to answer the question:
Why do firms measure Intellectual capital? , by sorting through, organizing and explaining
the diverse school of thoughts.
They narrowed it down to 5 main reasons for measuring IA. Organizations have internal and
external outlooks. The internal relates to monitoring, managing and developing the business.
The monitoring, developing and managing of a business is facilitated by measuring
intangible assets because measuring IA helps organisations to:
9

1.

Make development, diversification and expansion decisions

2.

Ensure fair and just compensation of employees and managers

3.

Develop KPIs (Key Performance Indicators) used in the assessment of strategies

4.

Formulate business strategies.

The 5th motive for measuring is to effectively communicate the intellectual capital measures
to external stakeholders, this is the external outlook.
2.3.1 Diversification and expansion decisions
Decisions to invest, diversify or expand are all strategic decisions. Mergers and acquisitions
are one of the vehicles through which these decisions can be implemented. According to
calculations done by PricewaterhouseCoopers, between 2001 and 2003 in 100 American
M&A deals involved transactions worth US$250 million, 74% of the purchase price was
allocated to goodwill and intangible assets and only 26% went to tangible assets2. This
allocation of a large percentage of the purchase price to intangible assets is common in M&A
deals involving knowledge intensive firms across the globe.
Sullivan Jr. and Sullivan Sr. (2000) cited two leveraging effects of intellectual capital.
Firstly, IA allows companies to create new organizational forms, business processes,
products, and services, in effect, leveraging their profitability. The second was the
contribution of Professor Stanley Davis in 1987, he predicted that successful companies in
the 21st century will be those who put more information/knowledge into their products.
To properly leverage IA (both acquirers and targets) and to avoid impairments and writedowns which often accompany M&A deals, it is of importance to be able to properly identify
and measure IA (Marr et al. 2003).
Intellectual capital can be created through strategic (marketing and technological) alliances.
On average, these alliances results in value creation for shareholders (Das et al. 2003). Gupta
and Ross (2001) said that the main reason behind most M&A deals is gaining access to
intangible resources and creating synergistic relationships with respect to intangible assets.
However failing to nurture and leverage IA through the measurement and understanding of
intellectual capital may defeat the whole purpose of the merger and acquisition strategy.

2.3.2 Communication with external stakeholders

Full disclosure of intellectual capital in financial statements is still in its infantry as
regulators have not reached a consensus on its definition, valuation and reporting. Still,

Yu, P., Intangible assets playing an important role in M&A deals,

PricewaterhouseCoopers, viewed 21 August 2015:

<http://www.pwc.tw/en/challenges/financial-advisory/indissue0268.jhtml>.

10

external stakeholders need complete information on which their decisions and valuation of
companies can be based.
Financial statements are the primary source of mitigating information asymmetry between
stakeholders, as already established, they fail to fully account for intangibles. Therefore, as
investment in intangibles increases, the average investor is worse off vis--vis information
and compared to informed insiders (Leadbeater 1999). In spite of the fact that insider trading
is illegal, information asymmetry is a good breeding ground for it. Aboody and Lev (2000)
found that from 1985 to 1997, insider gains in R&D intensive firms were much greater than
those in firms without R&D.
As Lev (2005) already mentioned, non-tradability of intangibles as a result of information
asymmetry makes investments in firms risky because of inaccurate valuation. This leads to
high cost of capital. Raising capital is more difficult for firms with a larger proportion of
intangible to tangible assets, compared to those with more tangible assets. (Leadbeater
1999). Intangible assets is not a collateral in the traditional sense (Luthy 1998). Boone and
Raman (2001) found higher bid-ask spreads and lower liquidity for R&D intensive firms
compared with less R&D intensive firms in their study of 340 US firms. There is also
evidence of higher bid-ask spread for R&D intensive firms globally (Zghal and Maaloul
2011). The bid-ask spread increased with the level of information asymmetry.
Proper measurement of and transparent disclosure of intellectual capital is therefore of
paramount importance in ensuring information symmetry.

2.3.3 Strategy formulation

In simple terms, a strategy is a plan of action laid down for the purpose of achieving long
and short term goals. Resources are needed to implement strategies. The resource based
theory of the firm is of the opinion that both tangible and intangible resources are relevant
to achieving superior performance. Therefore firms need to take into account the availability
of intangible assets at their disposal in strategy formulation.
Marr et al. (2003) observed that research in this area was more exploratory than empirical.
In Hall (1992)s survey of chief executives based in the United Kingdom, all the Chief
Executive Officers agreed that the principal contributors to the overall success of their
organisations where intangibles like employee know-how, company and product reputation.
Hall (1992) argued that the analysis of intellectual capital should play a vital role in the
strategic management process.
He went further to explore the role of intangible assets in business strategy in Hall (1993)
using 6 case studies covering 6 different kind of businesses. The response of the survey
supported his argument in Hall (1992).

2.4 Measurement of intangibles

Accounting practices when it comes to intangibles are limited. Costing some components
of intangibles like R&D is straightforward, easy to track and account for by firms, while

11

others are tricky. Benefits may not be reaped at all like in the case of a failed R&D effort
and, are not always matched to the cost in the same year. That combined with an almost nonexisting market makes accounting for intangibles difficult (Lev 2005).
However, accounting standards for some intangibles have existed for more than two decades,
allowing them to be included in traditional financial statements. Standards for accounting
for R&D was issued in 1977 under SSAP 13 (Statements of Standard Accounting Practice)
and in 1984, SSAP 22 for goodwill. Since then, accounting standards have been revised and
replaced with new ones. The IAS 38 (International Accounting Standard of the IASBInternational Accounting Standard Board 1998) is the result of this evolution. It was set with
the goal of dealing with the accounting for intangibles not dealt with in other standards.
Under IAS 38, intangibles are recognised if they are identifiable, can be controlled, the future
benefits arising from them in particular are probable and flow to the enterprise and, the cost
of the intangible asset can be reliably measured. Patents, licences, customer list, franchises,
marketing rights and computer software are examples of intangibles that can be included in
the balance sheet under the IAS 38. Items that do not meet the criteria above are expensed.
Examples of items that do not meet the criteria include advertising and training cost, and
internally generated goodwill (it is not identifiable and therefore cannot be reliably
measured).
There are difficulties in identifying intangibles that can be reported using this standard. IAS
38 defines control as the power to obtain future benefits from the intangibles and restrict the
access of others to those benefits3. So, most of what is generally regarded as intangibles, like
portfolio of clients or trained employees do not pass the recognition criteria since they cannot
be sufficiently controlled4. Given the limitation of intangibles included, financial statements
only provide a partial picture of the value of intellectual capital.
In Europe, notable initiatives geared towards encouraging the reporting of intellectual capital
include the Danish and MERITUM guidelines. The Danish guidelines are the product a
Danish government sponsored research. The guidelines is used in preparing intellectual
capital statements. Since publication in the year 2000, about 100 different firms have used
them5. MEasuring Intangibles To Understand and improve innovative Management,
MERITUM a project funded by the European Community resulted in the MERITUM
guidelines. The guidelines provide a framework to enable companies to manage and
externally report their intangibles.
The MERITUM project was born because the European Commission recognised that the
economy had shifted from an industrialised one to a new economy in which intangibles
played an important role in value creation. Due to the shortcomings of the accounting
system, stakeholders suffered economic loss due to lack of complete information. Also, the
3

https://inform.pwc.com/inform2/show?action=informContent&id=0947085303162318
Understanding corporate value: managing and reporting intellectual capital. Page 23.
http://www.cimaglobal.com/Documents/ImportedDocuments/intellectualcapital.pdf. Retrieved
08/06/2015
5
Intellectual Capital Statements the New Guideline.
http://pure.au.dk/portal/files/32340329/guideline_uk.pdf. Retrieved 08/06/2015
4

12

absence of a common framework to identify, measure and disclose information on intangible

determinants of value were incentive for the initiative. The project was done with the
aspiration of meeting all these needs, and enable investors to properly estimate the benefits
and risk of investment opportunities. (MERITUM 2002).
Many have come up with models/methods for measuring intellectual capital. Luthy (1998)
and Bontis (2001), to name a few, did an overview of the existing models. Sveiby (2001),
based on the work of Luthy (1998) and Williams (2000), classified 42 measuring approaches
into four main groups: Direct Intellectual Capital (DIC) methods, Market Capitalization
Methods (MCM), Return On Assets (ROA) methods and ScoreCard (SC) methods.
In DIC methods, the components of intangible assets are pinpointed and assessed
individually or collectively. Based on the components, the monetary value of intangibles is
obtained. Examples include Human Resource Costing and Accounting and the Technology
Broker.
Intellectual capital is the difference between the market capitalization and the equity book
value of a firm in the MCM category. Tobins q, Market-to-Book value, and Calculated
Intangible Value (CIV) are MCM.
Like DIC methods, ROA methods also estimates the monetary value of intangibles. Both
firm specific and industry average return on tangible assets are determined. The excess firm
average return over industry is obtained, multiplied by company average tangible asset and
divided by its cost of capital to obtain the value of the intangibles. Economic Value Added
(EVATM) and, Value Added Intellectual Coefficient (VAIC TM) are some examples.
SC methods: Indicators and indices are generated from the components of intangible assets.
The outcome is recorded in scorecards or graphs. Examples are Balanced Scorecard and, the
Skandia Navigator TM.
Balanced Scorecard (BSC): The main advocate is Kaplan and Norton (1992). Through the
use of BSC, the strategy and vision of an enterprise is instituted and managed in such a way
that they translate to reality. Indicators based on financial, internal process and learning
perspectives are used to measure performance. The BSC, widely applied as a strategic
performance and management tool, was not designed specifically to measure intellectual
capital. Marr and Adams (2004) explained that intangibles only became part of the Kaplan
and Norton learning and growth perspective in 2004 and that studies have shown that a this
perspective is not being used by a third of the BSC practitioners. Some companies however
fill in the gap with human resource or innovation measures (Marr et al. 2004).
Skandia Navigator TM: is based on the Edvisson/Malone approach (in Edvinsson, Malone
1997). Edvisson as part Scandia, a Swedish insurance and financial services, published the
Navigator to supplement their 1994 annual report. The idea behind it is that traditional
financial statements are based on past information only, therefore the current and future
ability of firms are not reflected in them. 73 traditional metric and 91 measures of intangible
assets were used to bridge that information gap and guide organizations in the management
of intangibles. Skandia is considered a pioneer in the world in two respects. It was the first

13

company to acknowledge the need and significance of intellectual asset and also the first in
the world, not just as a firm, to publish an intellectual capital report6.
Market-to-book value. An assumption is made that the market capitalization/ market value
of a firm is the approximate value of both its tangible and intangible assets. Intangible asset
is therefore calculated as the difference between the firm market and book value. There are
limitations to the use of M/B value because, firstly, the stock prices used in the calculation
are also affected by economic factors not related to the tangible and intangible assets of the
firm, and secondly, book values (depreciated historical costs) of tangible assets used in the
calculation differs from the true/market prices. Market-to-book value ratio is a more robust
measure as external factors are filtered in ratios and comparison between companies is
possible (Luthy 1998).
Tobins Q has the same concept as M/B ratio. The difference lies in the use of replacement
cost instead of book value of tangible assets. The rationale behind Tobins Q is that
Intellectual capital is as a result of competitive advantage, companies with that advantage
have a Q greater than the competitors and Qs greater than one (Luthy 1998). In using
replacement cost, Tobins q appears more accurate then M/B value approach.
Technology Broker: Brooking et al (1997) contribute to the measurement of the monetary
value of IA using their Technology Brokers IC (Intellectual Capital) audit. 20 diagnostic
questions are asked to companies in relation to human-centred assets, intellectual, property,
market and infrastructure assets. The logic was that lesser the strength of a companys
answers in the audit, the greater need it has to focus more on its intellectual capital. The
upside of the audit is the ability to identify, value and leverage IC (Bontis 2001). The
shortcoming is that the next phase of the valuation translates qualitative results from
questionnaires to quantitative measures. The monetary value intellectual capital is
determined using three methods: cost, market and income approach. They are based on
replacement cost, market multiples and the Net Present Value (NPV) of the asset
respectively. As earlier stated, there is lack of efficient multiples for intellectual capital,
making the market approach difficult. The NPV is subject to estimations and uncertainties
ingrained in the cash-flow model. Bontis (2001) suggests the Likert-type scale as a way to
give qualitative questions quantitative values.
VAIC TM s main proponent is Ante Pulic, co-founder of the Austrian IC (Intellectual Capital)
Research Centre. It measures how efficient a companys resources are in value creation.
That is how it adds value to the company. Three components; human, physical and structural
capital are used to obtain the measure. This method of measuring IA is easy to use as it
employs accounting data as its input. It is increasingly being applied in businesses and
business applications (Firer and Williams 2003).
Thomas A. Stewart is the major advocate of the CIV method. NCI Research group in Illinois,
USA, affiliated with the Kellogg business school of Northwestern University (Illinois)
developed the CIV to determine the fair market value of the intangibles of a firm. The idea
6

Intellectual capital report/statement is a disclosure made by a company on its intellectual capital. It

highlights how it develops, maintain and manage its IA resources and activities. It also shows how the
human, structural and relational capital are connected, and evolve with strategic objectives (MERITUM
2002)

14

was to see if Calculated Intangible Values will encourage lenders in the Chicago area to offer
more credits to a firm (Stewart 1997).
The four approaches have their advantages and disadvantage. The choice between them
depends on the purpose and context of the research. ROA and MCM offer monetary
valuation, providing a financial value for intangibles. Putting things in monetary terms
makes them easier to understand for most stakeholders. The ROA and MCM being based on
long established accounting rules means they are easily communicated and understood. They
are therefore useful in mergers and acquisitions and stock market valuations. They are also
useful in comparison between companies of the same industry. The downside of offering
just a financial perspective is the lack depth, fail to tell the whole story of organisations.
DIC and SC methods on the other hand can offer a more complete picture of an organization.
Scorecards like the Balanced Scorecard includes both financial and nonfinancial measures.
DIC and SC methods can be used at all levels of an organization not just management.
Stakeholders like management are accustomed to looking at things from a financial
standpoint so these methods may be difficult for them to embrace, but for the same reasons,
being non-financial, they are very useful to not-for-profit organisations and for
environmental and societal purposes (Sveiby 2001).

2.5 Germany and Intellectual capital

2.5.1 Accounting for intangibles in Germany
Wang H. (2008) paints a picture of the state of German accounting in the past. Private
companies, most of which were family-owned, controlled the German industry. As a result,
the needs of creditors, not the shareholders, influenced the important developments in
German accounting. The consequence of globalization, internationalization, and crossborder flow of capital and resources was an augmented interest in consolidated financial
statements. To maintain a competitive capital market, the German government granted
publicly listed companies the alternative of fully adopting the IAS in consolidated financial
statements but within the boundaries of European Union Directives.
The DRS 12 International Standard for Intangible Fixed Assets (of the DRSC Deutsches
Rechnungslegungs Standards Committee, 2002) and the DRS 15 Standard for
Management Reporting of Corporate Groups (DRSC, 2005), were issued to accommodate
the IAS standards on intangible assets in Germany (Alwert et al. 2009). Intangible assets are
defined as identifiable, standing in the power of disposal of the company (marketable), nonmonetary assets, without physical substance, which can be used for the production of
products or the provision of services, the provision for consideration of a third party or for
their own use7.Because of the identification and marketability criteria, intangibles not

DSRC: http://www.drsc.de/service/drs/standards/?ixstds_do=show_details&entry_id=18

15

recorded in the balance sheet are included in details in the management report according to
DRS 15.
Regardless of these developments, intangible assets are internally generated, making
identification and measurement subjective (Wang H. 2008). Frey and Oehler (2014) when
investigating the valuation methods employed for the measurement of intangible assets, the
feedback gotten was that the income approach was the most used valuation method.
Generally, inputs like future cash flow and discount rates used for the income approach are
subjective. Frey and Oehler (2014) questioned the reliability of reported intangible values.
There is therefore a need for more precise and comparable accounting framework for
intangible assets in Germany.
2.5.2 Growing importance of Intellectual capital.
Crass et al. (2014) investigated the role played by intangible assets in economic growth at
the sector level in Germany from 1995 to 2006. They examined 6 main industries in the
business sector namely: (1) Agriculture and mining (made of agriculture, fishing and mining,
(2) manufacturing, (3) Utility (constitutes electricity, gas and water), (4) construction, (5)
trade and transportation (wholesale and retail, hotels and restaurant, transport and
communication, all fall under it) and (6) financial and business services.
Crass et al. (2014) followed Corrado et al. (2009)s classification of intellectual capital into
three groups. Computerised information (chiefly computer software), economic
competencies (brand and firm-specific resources like human and organizational capital) and
innovative property (both scientific and non-scientific R&D).
They observed that investment by German enterprises in intangible assets had grown by 30%
from 1995 to 2006. Investment in Intellectual capital rose from 138.6 bn. to 180 bn. . The
surge was 100% in computerized information, 40% in innovative property and 25% in
economic competencies. Figure 2 illustrates this increase by sector. More than 50% of it is
attributed to the manufacturing sector.
An analysis of annual balance sheet and corresponding notes on intangibles and methods
used in their valuation was conducted on 30 German public companies listed on the DAX (
German stock market index) was conducted by Frey and Oehler ( 2014). Their research
revealed that intangible assets had attained importance, reported intangible assets increased
from 203 bn. (in 2005) to 283 bn. (2008 figure).
Frey and Oehler (2014) sought the opinions of German Chartered public Accountants
(CPAs) from 180 top auditing firms on intangible assets using questionnaires. The consensus
was the influence of intangibles on company performance was high and will be increasingly
so in the years that followed especially in manufacturing and high-tech industries.

16

Source: Crass et al. (2014) pp. 13.

Figure 2: Investment in intangible assets by sector, 1995-2006

2.6 Intangible assets and value creation

Value can be produced from intellectual capital. At an ICM Gathering8, members were asked
how they extracted value from IA. The result varied depending on the business strategy of
the company. The different types of values firms receive from IA include profit generation
(from sales of products and services and licensing), strategic positioning (market share,
reputation and recognition through branding and trademark), customer loyalty and improved
productivity (Harrison and Sullivan 2000).
The outcome of research has shown that average return on investment in intangibles like
R&D, patents, software and human resource can be high. Intangibles are inert, unable to
create value on their own. Manager capabilities and the implementation of appropriate
business strategies are the main forces behind the ability of an enterprise to create value from
intellectual capital. Prominent firms tie in their R&D activities with business strategy to
increase the efficiency of R&D processes (OECD 2006).
The value of a company can be seen in its market and book value. Book value equals total
assets minus total liabilities. The share price or the purchase price of a company represents
its market value. As already explained, accounting practices fail to capture the value of most
intangibles. The value of intellectual capital is better reflected in the market value.

The ICM Gathering comprises the people managing the business aspects of intangible assets for companies that are all
very sophisticated in extracting value from intangibles. Originally formed in 1995, the group has been meeting three
times yearly to teach each other about what new ideas or approaches we may have learned about how to extract more
value from our intangibles. http://www.unycom.com/interview-with-dr-pat-sullivan/

17

Sveiby (1995) asserts that the market value can be interpreted as an image of the invisible
balance sheet. The invisible balance sheet explains the difference between the market and
book value of a company. According to this concept, the market value is made up of visible
equity (net tangible assets) and intangible assets. Sveiby illustrates this in Table 1 showing
that intangible assets accounts for a greater proportion of the market value of some
established firms than intangible assets.

Table 1. Market Values of well-known companies consist more of intangible than tangible
assets
Daniel and Titman (2006) in their paper Market reaction to tangible and intangible
information decomposed stock return into tangible and intangible information. They
defined tangible information as information on past and current performance found in
accounting statements. All other information unrelated to tangible information are
considered intangible. Their results showed no discernible relationship between future stock
returns to the past accounting performance of a firm. A positive relationship between future
stock returns and intangible information was observed.
Results from the work of Sveiby and others have shown that intellectual capital is an
important source of value creation.

2.6.1 VAIC
Bornemann et al. (1999) say that in most approaches towards defining IA, intangibles are
seen as an aggregate term or value, more or less made up of 3 components; stakeholder
relationships, human and structural capital. Human capital (HC) is all factors in relation to
employees that foster performances customers are willing to pay for (Bornemann et al. 1999
pg. 8). On an individual level it is defined as a combination of genetic inheritance, education,
experience and attitude towards life and business (Hudson, 1993). This results in technical
expertise, problem solving, risk-taking and leadership ability (Salehi et al. 2014). Customer
and supplier relationship constitute stakeholder relationship. Structural capital refers to
everything that is left when people have gone at night (Edvinsson and Malone 1997, pg.
17). Tseng and Goo, 2005 illustrates that intellectual capital is an aggregate term in Table 2.

18

Developed by (Time)
Framework (Country)
Edvinsson and Malone (1997) Skandia Value Scheme (Sweden)
Bontis (1998)

Canada

Stewart (1997)

USA

Saint-Onge (1996)

Canadian Imperial Bank of Commerce (Canada)

Sveiby(1997)

Intangible Asset Monitor (Australia)

Van Buren(1999)

American Society for Training and Developement (USA)

Roos ei al. (1998)

UK

O'Donnell and O'Regan (2000)Ireland

Classification
Human capital
Structural capital
Human capital
Structural capital
Customer capital
Human capital
Structural capital
Customer capital
Human capital
Structural capital
Relational capital
Employee competence
Internal structure
External structure
Human capital
Innovative capital
Process capital
Customer capital
Human capital
Structural capital
Relational capital
People
Internal structure
External structure

Table 2: Classification scheme of intellectual capital.

VAIC is based on this school of thoughts. It is derived from human, structural capital and
capital employed.
The VAIC is built on the foundation that value is created from two main sources: physical
capital resources and intellectual capital resources (Kujansivu and Lnnqvist 2007). It
measures the total value creating efficiency from both resources. VAIC = ICE + CCE. ICE
(Intellectual Capital Efficiency) provides a measure of the value creation efficiency a firms
intangibles. CCE is Capital Employed Efficiency.
VAIC will be used to investigate if companies with greater intellectual capital have higher
M/B value ratios. Some studies using VAIC to investigate the relationship between IA and
firm value are:
De Barros et al. (2010) investigated the relationship between intellectual capital and value
creation in the Brazilian textile manufacturing sector. They found that intellectual capital is
positively related to value creation.
Companies listed on the Taiwanese Stock Exchange from 1999 to 2002 were used by Chen
et al. (2005) to investigate the relationship between VAIC and the M/B value ratios. Their
findings supported the hypothesis that a firms intellectual capital has a positive impact on
its market value. Tseng and Goo (2005) had the same finding using a sample based on only
Taiwanese manufacturers.

19

Firer and Williams (2003) in their investigation on the association between the value added
by a firms resource base and market valuation using 75 publicly traded intellectual capital
intensive South African firms observed that tangible assets where greater importance than
intangible assets when it comes to market valuation.
Another study in which the hypothesis that investors placed a greater value on firms with
higher VAIC was tested is Maditinos et al. (2011). 96 Athens Stock Exchange listed
companies from four economic sectors were used covering the period 2006 to 2008.
In Gan and Selah (2008) VAIC failed to explain market valuation in the Malaysian
technology intensive firms.

2.6.2 Calculated Intangible Value

Kohlbeck and Warfield (2007) used the banking industry to show the impact of unrecorded
(not found in financial statements) intangible assets on abnormal earnings and equity
valuation. They found that bank abnormal earnings vary with the level of unrecorded IA,
those with more unrecorded intangibles had more abnormal earnings and vice versa.
The primary idea behind Calculated Intangible Value (CIV) is that with the use of just
tangible and financial assets, companies will achieve just normal returns. Since intangibles
like R&D and brand are unique to firms, competitive advantage can be obtained using them,
resulting in abnormal profits. Any premium (abnormal profits) over competitors in the
industry is generated using intellectual capital. Based on this assumption, CIV is used to
obtain the monetary value of intangible assets (Kujansivu and Lnnqvist 2007).
The CIV as a measure of intellectual capital will be used to test to what extend intellectual
capital explains the market value of firms.
In practice, there is limited amount of research using CIV. Stewart (1995) used the CIV to
measure the Merck & Co.s intellectual capital. Kujansivu and Lnnqvist (2007), Richieri et
al. (2008) and Yang and Chen 2009 also employed it to value intellectual capital.
Volkov and Garanina (2008) studied the impact of tangible and intangible assets on the
market value of 43 Russian firms from 2001 to 2005. The role of intangible assets was not
as significant as tangible assets in value creation.
Aho et al. (2011) in their critical assessment of CIV attempted to establish how accurately
the profitability and market value of Finnish Stock Exchange listed firms (2004- 2008), are
described by CIV. CIV was positively associated with market value.
A positive relationship between CIV and value creation was found by Aguiar et al. (2009)
using companies in Brazils metal product manufacturing segment (2000 2006).

20

2.7 Intangible assets and performance

There are conflicting views on what constitutes corporate performance. In the traditional
view of the firm, shareholders had priority and performance involved creating value for
them. Donaldson and Preston (1995) in their paper on the stakeholder theory of the firm
depicted two input-output models. In the first one, employees, investors and suppliers
contributed input which was been transformed into output benefiting primarily the
customers. The second is a more advanced view in which all stakeholders; employees,
suppliers, shareholders, customers, society and government contributed inputs and they all
benefited from the outputs. Corporate performance involved meeting the needs of not just
the shareholders and is measured not with accounting profit allocated to shareholders, but
with the value added (total wealth created by the firm) (Riahi-Belkaoui 2003).
Superior performance, in the resource-based theory of firms, is obtained by creating and
sustaining completive advantage. Competitive advantage is seen as a value creating strategy.
Strategic resources (used to achieve this strategy) have to be rare, value creating, in-imitable
by competitors, non-substitutable and imperfectly mobile (not easily accessible to others).
Tangible and intangible assets available to the firm are strategic resources (Barney 1991).
Zghal and Maaloul (2010) observed that there were some researchers who considered just
intangible assets as strategic resources, emphasising that tangible assets do not meet all the
criteria listed above.
Traditional financial measures of corporate performance are the main decision making tools
for stakeholders. Productivity (input converted to output), profitability (revenue exceeding
cost) and market valuation (market and book value comparison) are the commonly used
measures of corporate performance. Conventional accounting principles are used in these
traditional measures. In a new economy where intellectual capital drives competitive
advantage, such measures may be unsuitable in decision making (Firer and Williams 2003).
A balanced measurement system therefore includes non-financial measures along with
financial measures of success. Lnnqvist (2003) defines success factors as measurement
tools or benchmarks/targets which must be reached for businesses to succeed. Profitability
and cost are traditional financial success factors. Quality, efficiency, time and volume of
products, services and operations are non-financial success factors. Both financial and nonfinancial success factors can be tangible or intangible. Lnnqvist (2003) provide examples
in Figure 3 below. Intangible success factors are success factors related to intangible assets.
Intangible assets are not only resources used to achieve superior performance but are tools
(success factor) used to measure performance.

21

Figure 3. Classification of common success factors.

Source: Lnnqvist (2003) pp. 281

2.7.1 VAIC
VAIC is a tool for measuring the relationship between intellectual capital and firm
performance. It will be used to investigate the extent to which traditional measures capture
the contribution of intangible assets to corporate performance. Prior research show mixed
results.
300 United Kingdom firms were used by Zghal and Maaloul (2010) to investigate the
impact of intellectual capital on financial performance as a whole. The result was positive.
Tan et al. (2007) had similar results on 150 Singapore exchange listed companies between
2000 and 2002.
Chen et al. (2005) found intellectual capital had a positive impact on profitability, as well as
productivity.
Nogueira et al. (2010) using a sample of the Leather Set Up, Leather Artefacts, Travelling
Products, and Footwear Sector in Brazil, and Ting and lean (2009) focusing on Malaysian
financial institutions (199-2007), both found a positive relationship between VAIC and
profitability (ROA).
Shiu (2006) examined the correlation between VAIC and corporate performance in the
Taiwanese technology sector. VAIC was correlated negatively with productivity and
positively with profitability and market valuation.
There was a lack of association of IA with profitability and a negative relationship with
productivity in Firer and Williams (2003).

22

2.8 Advantages and shortcomings of models employed

2.8.1 CIV model
Advantages
CIV provides information on the monetary value of a firm as well as its ability or inability
to outperform other firms within the same industry.
CIV allows for company-to-company comparison because of its use of data from audited
financial statements.
It is a useful benchmarking tool. A weak and falling CIV could be an indication that
investment in intangibles are not paying off or too much has been invested in physical assets,
while a rising CIV may indicate the inducement of capacity to produce future wealth
(Stewart 1995).
The CIV, Baruch Levs Intangibles Scoreboard and the Weightless Wealth Tool Kit
(Andriessen, 2004), are a few methods in existence for monetary valuation of intangibles.
Amongst these three, the only method which can be applied by an outsider to a firm, with
no access to specific internal information is the CIV. A thorough knowledge of a company
is needed to estimate expected future earnings. Expected future earnings is an important
input in the Intangibles Scoreboard. Managerial assessment is needed for the Weightless
Wealth Tool Kit (Kujansivu and Lnnqvist 2007).
Limitations
The CIV cannot be applied to companies with performance (ROA) below the industry
average because the value of CIV will be negative and meaningless.
Average ROA is used to calculate abnormal return attributed to IA. Averages by nature
suffer from outlier problems. This could result in overly high and low ROA (Ogilvie 2008).
The use of Industry average ROA is more problematic in cross-border comparison because
depreciation and taxation inputs in determining pre-tax income vary (Aho 2011).
The model assumes that excess returns are attributed to intangible assets, but other factors
like financial position and market structure also contribute to it, and they may not necessarily
be connected to intangible assets. ROA is connected to other drivers of success beside
intellectual capital (Aho 2011). It is possible that the excess return is from some other source
beside intellectual capital.

2.8.2 VAIC model

Advantages
Like CIV, all the data for the computation of VAIC TM is from audited financial statements
making computation and verification easy. Statistical analysis can be done over large
samples across time.

23

The use of traditional accounting data and simple straightforward steps in the computation
facilitates comprehension amongst managers and the business world.
Also, intra- and intercompany comparison both nationally and across borders is possible for
the reasons above as well as benchmarking.
The VAIC has been used in numerous research projects on intangible assets in different
nations and some researchers have concluded it is the most suitable method in existence
(Chan 2009a, Firer and Williams 2003, Chen et al. 2005).
Criticism
The main critic of Pulic (1998)s VAIC is Andriessen (2004). He found aspects of VAICs
conceptual framework which contradicted fundamental accounting principles. Iazzolino and
Laise 2013 examined the criticism below and tried to shed more light on it.
Pulic defines his Human Capital (HC) as the amount of capital invested in knowledge
workers and calculates it from wages, salaries and training cost. Andriessen (2004) says that
cost is confused with asset in this definition, they are treated as assets.
Structural Capital (SC) is calculated as SC = VA (Value Added) HC. Andriessen (2004)
argues that SC is a stock entity, not a flow as presented in the VAIC.
Sthle et al. (2011) in their paper Value Added Intellectual Coefficient (VAIC): a critical
analysis, found that Pulics concept of intellectual capital had nothing in common with that
in existing literature on knowledge management.
The International accounting Standard Board (IASB) define an asset as a resource owned
and controlled by an entity from which benefits are expected in the future, to flow to the
entity and expenses are defined as decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or incurrences of liabilities that result
in decreases in equity, other than those relating to distributions to equity participants9.
Iazzolino and Laise (2013) explained that though knowledge workers are not owned by a
firm to qualify as assets and be placed in the balance sheet of a firm, they could be seen as
an investment since future benefits to the firm are expected.
They agree with Sthle et al. (2011). Pulics concept of IA, HC and SC are indeed different
from those in existing literature. The confusion lies in the fact that he uses the same terms
as in other literature, but his definition of them differs.
Pulics main aim was to find a measure for the performance of a knowledge based
organization. The act that achieves a goal is the fundamental characteristic of the notion of
knowledge that Pulic is inspired bythe goal to achieve through the act is value creation
because only an organization that creates value is able to survive (Iazzolino and Laise 2013,
pg. 550). Pulic regarded VA (value creation per unit time of the intellectual labour force) as
the most appropriate indicator for the measurement of knowledge workers value creation.
SC is defined as the portion of VA residually obtained after deducting HC from VA. So with
9

http://www.accaglobal.com/content/dam/acca/global/pdf/sa_mar11_f7p2.pdf

24

Pulics definition of SC, he is justified in seeing it as a flow. The VAICs conceptual

framework does not contradicted fundamental accounting principles.
The main weakness Iazzolino and Laise (2013) discovered was with Pulics idea that VA
was to replace EBIT-based (Earnings Before Interest and Taxes) measures, since such
measures fail to unveil value creation to stakeholders. They explain that EVA (Economic
Value Added) for instance, measures value creation from the shareholders point of view
while VAIC takes the stakeholder (a broader) point of view. A better perspective than Pulics
one-dimensional view of firm performance measure, is to see VA as one of the measures of
performance, as a complement to the other existing measures. Pulic himself supported this
years later in a statement that the new concept (VAIC) [..] has a number of advantages
that, whilst not replacing existing measures, complement them in a significant way (Pulic,
2008, p. 7)10 . Huang and Wang (2008) studied 74 Taiwanese firms. The main contribution
of their paper was that EVA was the main determinant of firm value, but by adding R&D as
a proxy of intellectual capital, the model explanatory power increased significantly leading
them to conclude that EVA and intellectual capital were the two major contributors to firm
value.

10

Pulic, A. (2008), The Principles of Intellectual Capital Efficiency. A Brief Description, Croatian

Intellectual Capital Centre, Zagreb. Referenced in Iazzolino

25

and Laise 2013.

3. RESEARCH METHODOLOGY
3.1 Conceptual framework of models employed and research hypothesis
3.1.1 VAIC model
Income statement and statement of financial position (balance sheet) mostly satisfy the
information needs of shareholders. It neither reflects the contribution of the other
stakeholders nor the value or wealth created by a firm over a period of time. Value Added
Statements (VAS) are widely used to complement financial reports. Value Added is simply
defined as the value of inputs minus the value of outputs. It is used to appraise the
performance of enterprises. VAS is used for the purpose of calculating value added and is a
good tool for intra- and inter-firm comparisons (Mandal and Goswami 2008).
As mentioned above, Pulic (1998) saw VA as a measure of the value created by knowledge
workers. He believed that the Value Added Income statement is a tool for measuring the
value created from knowledge investment (Iazzolino and Laise 2013).
VA = Outputs Inputs
Outputs are the revenues from all the product and services sold in the market. Input
comprises all expenses, except labor, spent to generate the outputs. Pulic treated labour
expense as a value creating entity, not as a cost because of it plays an active role in the value
creation process (Tan et al. 2007).
Chen et al. (2005) came up with formulated VA below:
R = S B DP W I DD T
S B DP = W + I + DD + T + R
R is changes in retained earnings, S is net sales revenue, B is bought-in materials and
services, DP is depreciation expense, W is salaries and wages, I is interest expense, DD is
dividends , T is corporate tax. The right hand of the second equation is the net value added
and, on the left hand the distribution of value added amongst different stakeholders. NI is
net income, the sum of DD and R. The equation becomes;
VA = S B DP = W + I + NI

VA = Net sales (S) Cost of materials (B) Depreciation (DP)

HC, Human Capital is the sum of all expenditure on employees. Pulic(1998) argues that the
market determines salary based on work done (whether routine or analytical) and
performance, so it is logical to express the success of HC in the same way, in terms of salaries
and wages (Pulic 1998) Total expenditure on employees is used as a proxy for the value of
human capital.
HCE = VA / HC, HCE is Human Capital Efficiency.

26

CCE is the value added capital employed coefficient, the value added by one unit of capital
employed. Pulic assumed that companies with higher CCE generated greater returns, have
better ability to harness capital employed. He viewed this ability as part of the intangible
assets of a firm possesses (Tan et al. 2007).
CE: Capital Employed = physical assets + financial assets = Total assets Intangible assets
CCE = VA/ CE
Structural Capital (SC) is the difference between VA and HC. SCE, the structural capital
efficiency is
SCE = SC/ VA

VAIC = ICE + CCE,

ICE = HCE + SCE

In Pulic (1998)s literature on VAIC, he did not suggest that VAIC and its components, could
explain firm performance measured by traditional indicators (Iazzolino and Laise 2013).
Research investigating the VAIC and its components explanatory power have however been
done. And though the outcome has been mixed, there is evidence to suggest the relationship
holds in some countries.
M/B value ratio is used as a proxy for market valuation, ROA and Return on Equity (ROE)
for profitability and, Growth in Revenue (GR) and Employee Productivity (EP) are proxies
for productivity (Chen et al 2005, Firer and Williams 2003 and Chan 2009a).

Dependent variables:
-

M/B value ratio is measured by the market capitalisation divided by the book value
of common stock:
M/B = (number of shares outstanding x stock price at end of the year)
/ (book value of stockholders equity)

ROE is the return to shareholders of common stock.

ROE = pre - tax income /average stockholders equity.

ROA shows how efficiently assets are used in generating income.

ROA = pre - tax income /average total assets

GR = (current years revenues / last years revenues) - 1) x 100%.

EP: Employee productivity, is a measure of EP is a measure for the net value added
per employee.
EP = pre - tax income /number of employees

27

Independent variables:
-

VAIC, CCE, HCE, SCE

RD = R&D expenditure scaled by book value of equity to account for size effect

Control variables
-

Size = natural log of market capitalization

LEVerage (LEV) = total debt / book value of assets.
The dependent variables are affected by the size and leverage of the firms. These are
used as control variables in the regression analysis to remove the effects (Firer and
Williams 2003, Chan 2009, Shiu 2006).

Hypothesis
The following hypothesis were formulated based on the research questions;
H1.

Companies with greater VAIC have better firm performance; market valuation,
profitability and productivity.

H2a.

Companies with greater capital employed (physical capital) have better firm
performance; market valuation, profitability and productivity.

H2b.

Companies with greater structural capital have better firm performance; market
valuation, profitability and productivity.

H2c.

Companies with greater human capital have better firm performance; market
valuation, profitability and productivity.

H3.

Companies with greater R&D have better firm performance; market valuation,
profitability and productivity.

Regression models
Yi is used to represent the dependent variables.
Model 1:

Yi,t c 1VAICi,t 2 Sizei,t 3 LEVi,t i,t

Model 2:

Yi,t c 1CCEi,t 2 SCEi,t 3 HCEi,t 4 Sizei,t 5 LEVi,t i,t

Model 3:

Yi,t c 1CCEi,t 2 SCEi,t 3 HCEi,t 4 RDi,t 5Sizei,t 6 LEVi,t i,t

28

3.1.2 CIV model

Based on the assumption that any return above the industry average is attributed to intangible
assets, CIV is derived following the steps in Stewart (1997).
Calculate the companys pre-tax earnings a over the period of 2 years.
The 2 year average year-end tangible assets b is obtained from the balance sheet.
The return on asset c is a / b.
The industry average ROA is obtained in the same manner.
Check if the average ROA of the company exceeds the industry average. Proceed to
the next step only if it does.
6. Calculate the CIV
1.
2.
3.
4.
5.

The REOI (Residual Operating Income) model is used to obtain values for tangible (VT)
and intangible assets (VI) or the CIV. REOI is the residual earnings after subtracting
cost of capital from Net Operating Profits after Tax.
The fundamental value of assets according to the ROEI model is

VAREOI NA0BV
t 1

ROEI t
(1 kw )t

The fundamental value of equity:

VEREOI E0BV
t 1

BV ROEI t
ROEI t

D0
NA0
t
(1 kw )t
t 1 (1 k w )

Where
-

ROEIt NOPATt kw * NAtBV

1

NA0BV is the book value of net assets

k w is the Weighted Average Cost of Capital (WACC)

E0BV is the book value of equity and D0 the debt at the moment

After a series of assumptions and transformations,

VI (value of intangible assets) based on the REOI model is;
ROEI t
RONA RONAIAVG
VIREOI
NATBV *
kw
kw
VT (value of tangible assets) based on the REOI model is;
RONAIAVG
VTREOI NATBV *
kw

29

, where NATBV the book value of tangible assets, RONA is Return On Net Assets and
RONAIAVG: Industry Average RONA.
Hypothesis
The following hypothesis are tested;
H4a.
H4b.
H4c.

The market value of a companys assets depends on the fundamental value

of intangible assets.
The market value of a companys assets depends on the fundamental value
of tangible assets.
The market value of a companys assets depends on the fundamental value
of both intangible and tangible assets.

Independent variables:
-

VT
VI

Dependent variable:
-

PAM the market value of the companys assets

PAM = PEM + PDM sum of the market value of equity and debt
= Market capitalisation + Book value of debt

Regression models
Model 4:

PAM c 1VI 1

Model 5:

PAM c 1VT 2

Model 6:

PAM c 1VI 2VT 3

3.2 Data and sample selection

The data source is five year financial statements from 186 public German companies from
2009 to 2013. The names of the companies were obtained from Orbis (Bureau van Dijk)
database. Orbis contained 764 active, stock exchange listed, public German companies.
Enterprises with missing data where eliminated from the list. This further reduced the sample
to 186 firms. Data was collected from Orbis, company websites and COMPUSTAT Global.
Data for 896 firm -years where obtained. United States Standard Industrial Classification
(US SIC) Primary codes is used to get industry classification for the firms. Table I shows
the sample distribution by industry.

30

The entire sample was used to test the hypothesis under the VAIC model. Table II shows the
number of firms, firm-years and years over which the VAIC model was applied in other
published research papers. This paper is approximately halfway between the lowest and
highest ranking in terms of number of firms, firm years and years to ensure reliability of
results obtained. Table III provides descriptive statistics for the variables.

Number of:
Author(s)
Firer and Williams
(2003)
Maditinos et al.
(2011)

Firms

Years

Firm-years

75

approximately 75*

96

approximately 238
approximately 300

Table II.

Tan et al. (2007)

150

Comparing sample

Chen et al. (2005)

10

4251

used in different

This paper

186

896

research papers.

Note: * number obtained by multiplying number of firms by number of years

Firmyears

Industry

Percentage of
sample

Engineering, research &related services (87)*

28

3%

Transportation equipment (37)

Electronics, electrical equipment &
components (36)

65

7%

70

8%

Chemicals & allied products (28)

95

11%

Machinery & computer equipment (35)

95

11%

Clothing & apparel (22&23)

15

2%

Food and kindred products(20)

Transport & transportation services(4042,44-47)

60

7%

60

7%

Retail & wholesale (50-57 &59)

100

11%

Communications (48)

30

3%

Financial& insurance institutions (60-61)

30

3%

Metallurgy (33-34)

45

5%

Real estate (65)

49

5%

Business services (73)

124

14%

Table I.

Others

30

3%

Sample distribution

Total

896

100%

by industry

()* US primary SIC codes

31

Variable

Mean

Median

Maximum

Minimum

Std. Dev.

VAIC

2.901

2.782

27.356

-8.301

2.278

CCE

0.556

0.494

2.553

-0.089

0.388

SCE

0.279

0.412

7.026

-8.453

0.764

HCE

2.068

1.686

26.341

-0.438

1.883

RD

0.063

0.011

1.928

0.000

0.122

M/B

1.914

1.429

15.920

0.180

1.777

ROA

0.063

0.059

1.121

-0.926

0.110

Table III.

ROE

0.161

0.143

5.577

-1.371

0.343

Descriptive statistics

GR

0.068

0.051

3.306

-0.765

0.255

for selected variables

EP

0.040

0.012

1.808

-0.464

0.163

The CIV model could only be applied when the company RONA exceeded the industry
average RONA. Firm-years with negative CIV were thereby eliminated from the sample.
This reduced the number of firm years to 500. Table IV shows the distribution by industry.
Volkov and Garanina (2008) analysed Russian companies over a five-year period using 172
firm years. The number of firm years used in this paper is two times more than that of Volkov
and Garanina (2008).
Industry
Engineering, research &related services
(87)*

Table IV.
CIV model sample
distribution by
industry

Firmyears

Percentage of sample

20

4%

Transportation equipment (37)

Electronics, electrical equipment &
components (36)

23

5%

49

10%

Chemicals & allied products (28)

23

5%

Machinery & computer equipment (35)

Clothing & apparel (22&23)
Food and kindred products(20)
Transport & transportation services(4042,44-47)
Retail & wholesale (50-57 &59)
Communications (48)
Financial& insurance institutions (60-61)
Metallurgy (33-34)
Real estate (65)
Business services (73)
Total

73
5
23

15%
1%
5%

38
68
19
22
31
28
78
500

8%
14%
4%
4%
6%
6%
16%
100%

()* US primary SIC codes

32

3.3 Data analysis

3.3.1 Panel data
Panel data is used in testing the hypothesis under the VAIC model. The panel data contains
annual firm level data in two dimensions; individual (firm: i = 1,.,N, N = 896) and time,
t = 1, .,T, T = 5. Pooled OLS (Ordinary Least Square), random effects model and fixed
effects are the common ways in which panel data is estimated. Panel data offers more
efficiency than a single time series or cross-section series, because of the use of repeated
observations of the same unit, it allows specification and estimation of more complicated
and realistic models.
Pooled OLS is just an ordinary least square method applied to panel data. It assumes that all
individuals are the same, ignoring the differences between them. All coefficients (intercept
and slope coefficients) are the same across individuals and time. Fixed effects model is a
linear model in which all coefficients are the same across individuals and time, except the
intercept, it varies over individual units. It is common to refer to the intercept as the fixed
(individual) effects. This model allows for individuality. Random effects model assumes that
the intercept is random, it is treated as part of the error term and independent from the
explanatory variables. (Verbeek 2012).
The choice is usually between the fixed effects and random effects model. The Hausman test
is used in this paper for each regression, to choose between the two. Hausman test is one of
the ways in which the assumption made in the random effects model that the intercepts are
random, uncorrelated with the explanatory variables, can be tested. It estimates and
compares the coefficients with both models. The null hypothesis states that the random
effects model is the appropriate model to use.
3.3.2 Autocorrelation and heteroskedasticity
For the OLS estimator to be reliable, the Best Linear Unbiased Estimator (BLUE), certain
assumptions are made about the error terms. If the assumptions are not met, OLS ceases to
be BLUE. Autocorrelation occurs when the assumption that all the error terms are mutually
uncorrelated does not hold. Autocorrelation is common in time series data. When all the
error terms do not have the same variance (homoscedasticity), heteroskedasticity occurs,
resulting to unreliable standard errors and conclusions/inference about the coefficients.
Newey-West HAC standard errors and covariance are robust to both heteroskedasticity and
autocorrelation of unknown form. Eviews, the statistical software being used does not
support the use of HAC standard errors for least square estimation of panel data. Correction
of autocorrelation is not made. However, it allows for White period standard errors which
are robust to heteroskedasticity.
All other models (excluding those under the VAIC) are tested using time series data, Eviews
supports the use of Newey-West HAC standard errors and covariance for time-series data.

33

3.3.3 Hypothesis testing

Certain statistical tools were used to arrive at conclusions made. To examine the relationship
among variables, correlation analysis in conjunction with regression analysis is employed.
Adjusted R2 showed the goodness of fit of linear approximations, how well the variation in
the dependent variable are explained by the independent variables, enabling analysis and
comparison between models employed. Correlation coefficient of 0 - 0.09 is regarded as
trivial/practically zero, 0.1- 0.29 as weak, 0.3 - 0.49 as moderate, 0.5 0.69 as strong.
0.7 0.89 as very strong and 0.9 1 as nearly perfect.
The hypothesis were tested using t-test and F-test. The null hypothesis under the t-test is: the
explanatory variable has no statistically significant impact on the explained variable. That
of the F-test says that none of the explanatory variables has statistically significant impact
on the explained variable. The F-test is a joint test of significance of all regression
coefficients. Eviews provides the t-statistics, F-statistics and corresponding p-values. The
null hypothesis is rejected if the p-value is less than the chosen threshold value, alpha (the
level of significance).
To test hypothesis H1- H3, the effect of the independent variables on future firm
performance is also investigated using one and three year lagged explanatory variable. The
rationale is that effect of variables like R&D on firm performance may not be evident in the
current year so it may be worthwhile to investigate its contribution to future performance.
Using one and three - year lagged independent variables reduced the sample size from 896
to 716 and 356 observations for lagged one and three-year samples respectively.
3.3.3 Industry Average RONA
The industry average Return On Asset is computed using the Peer analysis tool in Orbis.
Extreme outliers are eliminated from the population of companies under the US primary SIC
code used. This reduces the possibility of getting overly high or low averages.
3.3.4 R&D intensity
There is plenty of research that have proved that there is a relationship between R&D and
firm performance. This paper will investigate if firms with higher R&D perform better. The
average RD (R&D expense / book value of equity) was calculated for each industry. An
average based on the sum of all the results obtained was used as a benchmark on which the
companies were classified as R&D intensive and non R&D intensive firms. This
classification is applied to the correlation analysis performed. The classification is shown in
Table V. Crass et al. (2014) in their analysis of German forms from 1991 to 2008 found that
90% of R&D was done by manufacturing firms and the R&D spending for firms in the
Business and related services sector increased from 1.7% in 1991 to 9.4% in 2008. Firms in
these two sectors were the most R&D intensive. This corresponds to the results in Table V.

34

Table V.
R&D
intensity

R&D intensive firms

Non R&D intensive firms

1.Engineering, research &related services (87)*

1.Clothing & apparel (22&23)

2.Transportation equipment (37)

3.Electronics, electrical equipment & components
(36)
4.Chemicals & allied products (28)
5.Machinery & computer equipment (35)
6.Metallurgy (33-34)
7.Business services (73)

2.Food and kindred products(20)

35

3.Transport & transportation services(40-42,44-47)

4.Retail & wholesale (50-57 &59)
5.Communications (48)
6.Financial& insurance institutions (60-61)
7.Real estate (65)

4. EMPIRICAL RESULTS UNDER VAIC FRAMEWORK

4.1 Market valuation: M/B value ratio
Table VI presents the correlation analysis between M/B value ratio and the dependent
variables for the VAIC models. The analysis show that M/B is positively related to CCE and
not significantly related to VAIC, SCE and HCE. It is positively related to RD supporting
Chen, Cheng, & Hwan (2005) argument that RD captures additional performance relevant
information not included in SCE. Based on that additional correlation analysis is done and
Table VII compares the results of the full sample, R&D intensive firms and non R&D
intensive firms. The relationship between M/B and VAIC is still insignificant. The positive
relationship with CCE is chiefly associated with Non R&D intensive firms. RD is still
positively related to M/B but more so in RD intensive firms. The overall results suggests that
RD is of value relevance, higher R&D intensities lead to higher M/B value ratios and CCE
makes some contribution to the market value of non R&D intensive firms.

Correlation

Table
VI.
Correlation analysis
of the full sample.

MB

VAIC

CCE

SCE

HCE

MB
VAIC
CCE
SCE
HCE

1.000
0.025
0.162*
0.052
-0.010

1.000
0.029
0.654*
0.969*

1.000
0.089**
(0.179)*

1.000
0.522*

1.000

RD

0.324*

(0.09)**

0.121*

-0.061

-0.112

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Correlation
Full sample
R&D intensive
Non R&D intensive

MB
MB
MB

VAIC

CCE

SCE

HCE

RD

0.05
0.041
-0.075

0.162*
0.070
0.159*

0.052
(-0.097)**
0.001

-0.010
0.114**
(0.108)**

0.324*
0.329*
0.168*

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Table VII. Correlation with M/B ratio across different samples.

The results of the regression analysis with M/B ratio as the explained variable are presented
in Table VIII. Model 1 depicts a slightly negative VAIC coefficient, though not significant
in the current year is significant for 1 year future performance. Combined with the
correlation analysis, it appears that firms with higher VAIC do not have better M/B value
ratio. In Model 2, firms with higher CCE have higher M/B ratio in the same year and one
year ahead. SCEs coefficient is never statistically significant and HCEs is slightly negative
in the current year. Firms with higher R&D have higher M/B ratio, the effect is more visible
with one year lagged RD.

36

RD

1.000

4.2 Profitability: ROA and ROE

Table IX presents the correlation analysis results between the dependent variable under
hypothesis H1-H3 and ROE. There is a weak positive correlation between ROE and VAIC,
SCE, CCE and HCE. RD has a negative correlation with ROE. The association between
VAIC, its components and ROE is more significant, positive and stronger for R&D intensive
firms compared to non R&D intensive firms. This is supported in Table X containing the
results of regression analysis across the full sample, R&D intensive and Non R&D intensive
firms.
Dependent variable: M/B
Future :

Current
Independent
variables
Model 1:

VAIC
Adjusted R

F-statistic
Model 2:

CCE
SCE
HCE
Adjusted R2
F-statistic

Model 3:

CCE
SCE
HCE
RD
Adjusted R2

lagged 1
year

lagged 3 year

Coefficient

t-statistic

Coefficient

t-statistic

Coefficient

t-statistic

-0.015
0.879
28.421*
0.522
0.021
-0.061
0.849
28.37*
0.463
0.032
-0.060
1.417
0.853
29.068*

-0.296

-0.115
0.018
5.394*
0.531
-0.270
-0.078
0.030
5.513*
0.419
-0.210
-0.069
3.254
0.110
16.82*

(2.049)*

-0.021
0.003
1.312
-0.374
-0.029
0.128
0.859
12.855*
-0.330
-0.056
0.128
-1.300
0.861
12.92*

-0.262

1.632**
0.089
(1.769)**

1.512
0.131
(1.685)**
1.642**

2.24*
-1.639
-1.535

2.122*
(1.858)**
-1.565
1.842**

-0.910
-0.061
0.682

-0.791
-0.112
0.696
-0.425

F-statistic
Note: * indicates t-statistic is significant at of 5% and ** alpha of 10%. F-statistic * at of 1%. ()
indicates negative numbers.
Table VIII. Regression results for M/B value ratio.

Correlation

VAIC

CCE

SCE

HCE

RD

Full sample

ROE

0.209*

0.127*

0.205*

0.141*

(0.093)*

R&D intensive

ROE

0.405*

0.232*

0.39*

0.245*

(0.16)*

Non R&D intensive

ROE

0.112**

0.076

0.069

0.093**

0.041

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Table IX. Correlation with ROE across different samples.

37

The full sample regression results of the models with ROE is shown in Table XI. ROE has
a significant positive relation with VAIC, CCE and HCE and a negative relation with RD.
Firms with higher VAIC, CCE and HCE have higher ROE.
Dependent variable: ROE
Full sample
R&D intensive
Independent
variables

Non R&D intensive

Coefficient

t-statistic

Coefficient

t-statistic

Coefficient

t-statistic

-0.093
0.041
0.061
20.663*

-1.490
3.698*

-0.243
0.067
0.603
8.38*

-1.016
1.959*

-0.483
0.036
0.783
18.42*

-1.492
2.482*

-0.396
0.189
0.024
0.042
-0.240
0.736
14.514*

(2.03)*
2.604*
0.706
2.137*
(1.421)*

-0.257
0.142
0.025
0.082
-0.231
0.615
8.569*

-1.219
1.832**
0.420
1.842**
-1.499

-0.544
0.191
0.034
0.032
-0.618
0.781
17.589*

-1.608
1.193
1.835**
1.610
-0.885

Model 1:
Intercept
VAIC
Adjusted R2
F-statistic
Model 3:
Intercept
CCE
SCE
HCE
RD
Adjusted R2
F-statistic

Note: * indicates statistic is significant at of 5% and ** alpha of 10%. () indicates negative numbers.

Table X. Regression analysis of ROE across different

samples.

Independent

Model 1:

Coefficient

t-statistic

Coefficient

t-statistic

Coefficient

VAIC

0.041
0.061
20.663*
0.179
0.026
0.043
0.734
14.44*
0.189
0.024
0.042
-0.240
0.736
14.514*

3.698*

0.016
0.738
14.87*
0.094
-0.003
0.018
0.748
15.467*
0.101
-0.005
0.018
-0.149
0.757
16.11*

3.60*

0.038
0.006
1.027
0.245
-0.069
0.064
0.045
1.23**
0.247
-0.069
0.064
-0.029
0.010
1.22**

R2

F-statistic
CCE
SCE
HCE
Adjusted R2
F-statistic
Model 3:

ROE

variables
Adjusted
Model 2:

Dependent variables
ROA
GR

CCE
SCE
HCE
RD
Adjusted R2

2.533*
0.752
2.144*

2.604*
0.706
2.137*
(1.421)*

2.761*
-0.233
2.200

2.872*
-0.319
2.205*
(1.74)**

EP
tstatistic

1.186

2.079*
-0.777
2.09*

2.081*
-0.782
2.08*
-0.375

Coefficient

t-statistic

0.017
0.554
7.101*
-0.001
-0.018
0.030
0.565
7.325*
0.000
-0.018
0.031
-0.025
0.567
7.279*

1.659**

-0.030
-1.372
1.859**

0.006
-1.400
1.856**
-0.834

F-statistic
Note: * indicates t-statistic is significant at of 5% and ** alpha of 10%. F-statistic * at of 1% and ** at 5%. () indicates
negative numbers.

Table XI. Regression results for profitability and productivity

models.

38

The correlation analysis of VAIC, its components and RD on ROA produced similar results
as that of ROE. VAIC, CCE and HCE have a weak positive significant relationship with
ROA. RD is still negatively correlated. SCE is moderately positively correlated with ROA.
In comparing R&D intensive and non R&D intensive firms, again, the results of the former
are more significant, positive and stronger than the latter. For instance the correlation
coefficient of SCE with ROA is 0.505 and significant at 1% for R&D intensive firms, while
that of non R&D intensive firms is 0.108 and significant ta 5%. This can be seen in Table
XII below.
Correlation

VAIC

CCE

SCE

HCE

RD

Full sample

ROA

0.275*

0.269*

0.353*

0.131*

(0.209)*

R&D intensive

ROA

0.498*

0.286*

0.505*

0.287*

(0.312)*

Non R&D intensive

ROA

0.117**

0.251*

0.108**

0.064

0.089**

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Table XII. Correlation with ROA across different samples.

From the regression analysis, firms with higher VAIC, CCE and HCE have higher ROA.
The coefficient of RD suggest a negative relation with ROA. That of SCE is insignificant
(Table XI).

4.3 Productivity: EP and GR

Regression analysis convey a positive significant connection between VAIC and HCE with
EP (Table XI). This is supported by a strong positive correlation between the variables in
Table XII. Enterprises with higher VAIC and HSE have higher EP. The coefficients of CCE,
SCE and RD are all insignificant, the variables themselves are weakly correlated to EP. The
correlation analysis of EP and GR with the independent variables is displayed in Table XIII.
Table XI depicts the regression analysis.
Both the correlation and regression analysis imply negative, insignificant relationships
between RD and SCE with GR. They also indicate weak positive link between GR and HCE.
VAIC has little or no connection with GR. The significant positive coefficient of CCE is not
reinforced by the correlation analysis.
Correlation
EP
GR

VAIC
0.504*
0.094*

CCE
(0.155)*
0.041

SCE

HCE

RD

0.132*
-0.034

0.593*
0.118*

(0.110)*
-0.00801

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Table XIII. Correlation with EP and GR.

39

4.4 Future performance

In addition to M/B value ratio, lagged independent variables were regressed on the other
four performance measures. Most of the results were insignificant except that of VAIC and
HCE on EP. Table XIV conveys the outcome and compares current and future performance.
The coefficient of VAIC increases from 0.017 significant at 10% to 0.03 significant at 1%.
That of HCE follows the same trend from 0.031 at 10% to 0.048 significant at 1%. Firms
with higher VAIC and HCE have higher EP both simultaneously and in the future.
Dependent variable: EP
Current year
Independent variables

1 year lag

3 year lag

Coefficient

t-statistic

Coefficient

t-statistic

Coefficient

t-statistic

0.017
0.554
7.101*

1.659***

0.031
0.133
37.565*

3.159*

0.030
0.169
25.054*

4.01*

0.031
0.567
7.279*

1.856***

0.052
0.230
37*

3.94*

0.048
0.21
16.623*

4.48*

Model 1:
VAIC
Adjusted R2
F-statistic
Model 3:
HCE
Adjusted R2
F-statistic

Note: * indicates statistic is significant at of 1% and ** alpha of 5% and*** at 10%. () indicates negative numbers.

Table XIV. Effect of current and future VAIC and HCE on EP.

On average, the adjusted R2 increases across Models, R2 Model 3 > R2 Model 2 > R2 Model
1. This supports Chen et al. (2005)s finding that additional information is gleaned by
splitting VAIC into its components and including R&D expense.
Regarding the control variables, SIZE contributed positively and significantly in predicting
all of the performance measures. Leverage did the same for all, excluding the profitability
measures: ROE and ROA.

40

5. EMPIRICAL RESULTS UNDER CIV FRAMEWORK

5.1 Market valuation of assets
The correlation analysis between the value of intangible assets and the value of tangible
assets, with the market value of assets are shown in Table XV. The results of the regression
analysis of model 4 6 are displayed in Table XVI.
The coefficient of VI is 1.2 and significant at 1%. The market value of assets in German
companies is dependent on the value of intangible assets. Intangible assets explain 96% of
the variations in the market value of assets. The value of tangible asset has a coefficient of
0.4 significant at 1%. The market value of asset is also dependent on intangible assets and
52.7% of its variation is explained by it.
The correlation results and the regression analysis of Model 6 imply that the market value
of assets depends on both the value of tangible and intangible assets, and the contribution
made by intangible assets to the market value of assets is greater than that of tangible assets.
The market places greater value on intangible assets.
Correlation

PMA

p-value

VI

0.98

VT

0.729

Table XV: Correlation analysis of regression variables under the CIV framework.
Dependent variable : PMA
Independent variables

Coefficient

t-statistic

157.067

1.94**

1.209

24.045*

Model 4:

Intercept
VI
Adjusted R

0.960

F-statistic

0.0*

Model 5:
Intercept

1701.595

4.437*

VT

0.400

3.395*

Adjusted R2

0.527

F-statistic

0.0*

Model 6:
Intercept
Table XVI.
Regression analysis

VI
VT

of models under CIV

Adjusted R

framework.

F-statistic

208.104

2.871*

1.128

15.852*

0.050

2.434**

0.964
0.090*

Note: * indicates statistic is significant at of 1% and ** alpha of 5%. ( ) indicates negative numbers.

41

5.2 M/B, ROA, ROE, EP and GR

Regressing the Calculated Intangible Value (CIV) and the calculated tangible value on M/B,
ROA, ROE, EP and GR produced no significant results and very low R 2, as low as 0.05.
The correlation analysis is depicted in Table XVI below. The CIV has a very weak
relationship with the M/B and EP ratios. It has no relation to firm profitability.

Correlation

MB

VI

0.10**

VT

0.000

ROA
0.041
0.069

ROE

GR

EP

0.026

-0.017

0.093**

0.063

0.000

0.212*

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Table XVII: Correlation of VI and VT with performance

measures.

6. ADDITIONAL ANALYSIS OF MARKET VALUATION

USING MARKET CAPITALIZATION
So far, the relationship between intellectual capital and market value has been analysed using
market-to-book value ratio and the market value of assets of firms. Further analysis is carried
out using market capitalization to shed more light on the value relevance of intangible assets.
Balance sheet reported intangible assets, VAIC and CIV will be used as measures of
intangible assets.
Although the primary objective is to investigate how the market perceives intangible assets
when determining the value of the firm, the value relevance of accounting numbers, reported
intangible and fixed assets, will also be examined. Regression and correlation analysis are
employed.

6.1 The model

Landsman (1986) did an empirical studies on the value relevance of pension fund asset
and liabilities, as valued by the securities market. He uses the Market Value of Assets
(MVA) and Liability (MVL) to explain the Market Value of Equity (MVE).

MVE 1MVA 2 MVL

42

MVA and MVL are made up of the market value of the firms non-pension and pension
liability and assets.
Barth et al. (1992) used net income only to explain MVE when investigating the market
valuation implications of pension cost reported in income statements.
McCarthy and Schneider based on the work of Landsman (1986) and Barth et al. (1992)
came up with a new model:

MVE 1 ASSET 2 LIAB 3 INC

(1)

, where LIAB is liability and INC is an income variable. Godfrey and Koh (2001) used
a similar model in their study of the relevance to firm valuation of the capitalising of
intangible assets. They excluded the income variable. The model will be restated used in
this paper.
Model 7: MCAP 1INTAN 2 PPE 3 LIAB 4 INC

MCAP 1VI 2VT 3 LIAB 4 INC

Model 8:
Model 9:

MCAP 1VI 2 PPE 3 LIAB 4 INC

Model 10:

MCAP 1VAIC 2 PPE 3 LIAB 4 INC

, INTAN is the balance sheet reported intangible assets, PPE is the reported net fixed
assets, INC is net income and LIAB is like before.

6.2 The results

The results of the regression and correlation analysis are presented in Table XIX and
XVIII below. There is no significant relation between VAIC and MCAP (Model 4).
Neither is it related to the reported intangible and net fixed assets. PPE is positively
related to MCAP, the relationship is stronger in Model 3 compared to Model 1. INTAN
is also positively related to MCAP. Both the balance sheet reported intangible and net
fixed assets are of value relevance in terms of market capitalization.
Although VT is strongly correlated to MCAP, it fails to explain MCAP. CIV (VI) has the
highest correlation coefficient with MCAP at 0.99 and a positive coefficient significant
at 1%. The model with the highest goodness of fit is Model 3 at an adjusted R2 of 100%.
The market takes into consideration both the reported tangible and intangible assets when
valuing German companies. VAIC is not a good proxy for intangible assets when
investing their value relevance. The CIV fits the bill perfectly especially in Model 3.

43

Table XVIII.
Correlation analysis
MCAP models.

Correlation

MCAP

INTAN

PPE

VAIC

VI

VT

MCAP
INTAN
PPE
VAIC
VI
VT

1.000
0.815*
0.855*
0.027
0.99*
0.687*

1.000
0.709*
0.013
0.818*
0.532*

1.000
-0.057
0.847*
0.745*

1.000
0.034
0.020

1.000
0.691*

1.000

Note: * indicates correlation is significant at of 1% and ** at of 5%.

() indicates negative number

Dependent variable: MCAP

Independent variables
Model 1:

Coefficient

t-statistic

2.54**
1.652***

F-statistic

1.238
0.937
0.845
0.0*

VI

0.766

51.59*

0.000
0.997
0.0*

-0.657

0.750
0.500
1.000
0.0*
82.176
1.440
0.785
0.0*

2.01E+16*
1.64E+15*

INTAN
PPE
Adjusted R2

Model 2:

VT
Adjusted R

F-statistic
Model 3:

VI
PPE
Adjusted R2
F-statistic

Model 4:

VAIC
PPE
Adjusted R2

1.552
1.769***

F-statistic
Note: * indicates statistic is significant at of 1% and ** alpha of 5%, *** at of 10%. ()
indicates negative numbers.
Table XIX. Regression results for MCAP.

44

7. DISCUSSION
Hypothesis H1 says that companies with greater VAICTM have better firm performance;
market valuation, profitability and productivity. No significant relationship was observed
between VAIC TM (as a measure of the efficiency of intangible assets) and market valuation
measured by market capitalisation and market-to-book value ratio. Gan and Selah (2008) on
Malaysian technology intensive firms and Chu et al. (2011) on firms in the Hang Seng Index,
Hong Kong Stock Exchange (2005 -2008), had similar results.
There is a weak positive association between VAIC TM and the profitability measures: ROA
and ROE. In both cases, the relation was stronger for R&D intensive firms compared to nonR&D intensive firms. Firer and Williams (2003) and Chan (2009b) also found weak positive
associations. VAIC TM has no connection with Growth Rate and a positive one with
Employee Productivity, EP and VAIC TM has the highest correlation amongst all the
performance measure of 0.5.
Hypothesis 2a deals with Capital Employed Efficiency. CCE has a positive significant
relationship with M/B, ROA, ROE and GR but not with EP. It is the only component of
VAIC TM , including the VAIC TM itself, to be positively related to all the financial measures
and the strongest predictor. Chan (2000b) had the same observation. CCE has the greatest
contribution to financial performance amongst the three intellectual capital components
The connection between HCE and financial performance is tested in hypothesis 2b. HCE
predicts M/B value with a negative coefficient. Firer and William (2003) observed that the
South African market appeared to reward companies who increased their capital employed
and reacted negatively to those who increased their human capital. Chan (2009b)s results
pointed in the same direction. However, in terms of profitability and productivity, HCE
contributes positively. The highest correlation under the VAIC framework was between
HCE and EP at 0.595.
Hypothesis 2c was not supported on any level. Structural capital efficiency had no
connection with market valuation, profitability or productivity. Pulics definition of
structural capital was the part of his framework that was most criticised and least understood.
Chen et al. (2005)s argument could be an explanation for the lack of a relation between
market valuation and profitability with SCE. He argued that SCE is incomplete and needs
R&D and advertising expense added to it. Edvinsson and Malone (1997)s definition of
structural capital as everything left behind at the end of a work day includes techniques,
procedures and programs which can be used to enhance the delivery of goods and services.
R&D and advertising expense are therefore contributors to structural capital. In this paper,
RD had a strong positive relationship with M/B value and a negative significant relationship
with profitability. This suggests that Chen et al. (2005) are justified in their argument. The
fact that R&D is an expense means it reduces pre-tax income and subsequently ROA and
ROE, explaining its negative association with the two ratios.
The interaction and combination of the components of intellectual capital is what creates
value, no single component can create value on its own (Edvinsson and Malone, 1998).
Wang and Chang (2005) observed that the Balance Scorecard suggested a
relationship/connection existed between the financial, customer and internal process

45

perspective. Motivated by this, the authors used partial least squares method to investigate
the cause-effect relationship between the components of intellectual capital themselves and
between them and business performance. They found that structural capital (innovative and
process capital) and customer capital all had direct effects on performance. Human capital
on the other hand had an indirect effect on performance, it affected both the structural and
customer capital which in turn influenced performance.
According to Bontis (1998), for organisations to leverage their intellectual capital, there must
be a constant interaction between human and structural capital. The author states that:
Isolated stocks of knowledge found in the employees minds cannot positively affect
performance if they are not codified into organizational knowledge and shared with other
members of the organization. It is these efforts to codify organizational knowledge and
thereby further develop the firms structural capital that ultimately yield a sustainable
competitive advantage, which then translates into a higher performance (Bontis 1998, pp.
71). Looking at the correlation between the components of VAICTM, that which stands out
is a correlation coefficient of 0.522 between HCE and SCE.
Hypothesis H3 in on R&D. As mentioned above, it has a positive relation with M/B;
negative relation with profitability. No significant relation was found with productivity.
Smith, Percy and Richardson (2001) examined Canadian and Australian firms and found
that there was value relevance in the discretionary capitalisation of development cost by
managers. Godfrey and Koh (20101) also found evidence in Australia that capitalisation of
intellectual capital provided value relevant information. Chan, Lakonishok and Sougiannis
(2000) examined if the market in the United States fully valued intangible assets, especially
R&D. They found a relationship between R&D and stock return, companies with high R&D
intensity (R&D to market capitalisation) had larger excess returns. Lev and Sougiannis
(1996) and Aboody and Lev (1998) also observed a positive association between R&D and
market valuation in the US.
Sthle et al (2011) tested Pulic (1998)s VAIC TM on 125 listed Finnish companies from 2006
2006 in an attempt to examine what exactly the VAIC TM method measures. Based on their
findings, they concluded that the VAIC TM was just a measure of labour and capital employed
efficiency and had nothing to do with intellectual capital. In this paper, CCE had the
strongest overall results with all the firm performance measures and the correlation between
VAIC and HCE with employee productivity were the highest found. This seems to suggest
that Sthle et al. (2011) were justified in their criticism of Pulics VAIC TM .
Crass et al. (2014) in their sector level analysis of investment in intangible assets in Germany
found that in all the sectors, growth in intangible assets stimulated labour productivity
growth. This result was not limited to Germany only, investment in intangible assets
stimulated growth in labour productivity by 0.84 percentage points in the United States, 0.58
in the United Kingdom, 0.53 in Germany, 0.34, 0.19 and 1.8 points in Italy, Spain and
Sweden respectively (Crass et al. 2014). This suggests that the association with labour
productivity is not unique to the VAIC, but is due to the fact that it is a measure of the
efficiency of intellectual capital.
Using other measures of intellectual capital, research has proven that there is a relationship
between intellectual capital with the value creation and performance of firms. Wang J. C.
(2008) found that for firms listed on the Standard & Poors 500, a positive relation existed
between intellectual capital and market value, Yang and Kang (2008) observed that

46

innovative and customer capital had a positive impact on firm performance, Richieri et al.
(2008) in their study of 1,000 biggest companies in Brazil from 2000 2005 found a positive
relation between the calculated intangible value and ROA, ROE and ROS (Return On Sales).
A positive relation between VAIC TM and market value was observed in Pulic (1998), Chen
et al. (2005), Nimtrakoon (2014) and Shiu (2006). In Ghosh and Mondal (2008), Clarke et
al. (2011), Rehman et al. (2011) and Zghal and Maaloul (2010) VAIC TM was positively
associated with profitability.
So, although there are conflicting results from different research papers, it may be imprudent
to conclude that VAIC TM has nothing to do with intangible assets. The basic reason for the
differences is that the majority of the research is based on specific countries, industries, or
indexes. Theses may have characteristics which are unique to them like economic, tax and
accounting systems, economic/business cycles and culture. The second reason is the fact that
research was mostly done on public companies, with not too large sample sizes covering an
average of 1 to 3 years. It may therefore be inappropriate to generalise these results to other
countries, sectors, indexes and the whole economy of a country (Javornik et al. 2012).
Further VAIC-based research still needs to be done across sectors, countries and larger time
frames. The definition and composition of the structural capital component also requires
improvement. Despite its weaknesses, so far results obtained from VAIC-based research has
been promising and new developments in the model will make it a useful tool in measuring
intellectual capital.
Both the value of intangible assets (the CIV) and the value of tangible assets contribute to
the market value of assets of firms, with the CIV contributing the most. Although no
relationship was found between the CIV and profitability and productivity ratios in
Germany, Richieri et al. (2008) found they were related in Brazil.
Additional analysis of market valuation using market capitalisation showed that balance
sheet intangible and net fixed assets are of value relevance. VAIC TM was not related to
recorded intangible, net fixed assets (PPE) and market capitalization. The CIV had results
completely opposite to that of the VAIC. The best model explaining market value was that
with the CIV and PPE as independent variables with an adjusted R 2 of 0.997.
Both CIV and calculated tangible assets are positive correlated with the recorded intangible
assets and PPE. VAIC and its components are not correlated with either one. Answering the
question of if VAIC is really associated with intellectual capital will require additional
research which is not covered in this paper.
Leadbeater (1999) proposed that accountants will find it much easier to value intellectual
assets if a striving market for them exist. Policy makers can make this a reality by creating
intangible options market, insurance markets in which intangible assets can be insured
against loss, and more patents and trademark to cover intangible assets not currently covered.
With the combined efforts of academics, practitioners and policy makers, advances in the
measurement of intellectual capital can be made.

47

8. CONCLUSION
VAIC TM is unrelated to M/B value and weakly, positively related to ROA, ROE and EP.
Models with VAIC TM as an aggregate measure have lower explanatory power than those
with the three components of VAIC. Decomposing VAIC TM into its components offered
more intuitive results.
Based on the findings in this paper, the market to book value gap is mostly attributed to CCE
and R&D expenditure. Increase in human capital affects market-to-book value negatively
while increase in CCE and R&D expenditure has the opposite effect. CCE and HCE are key
contributors to profitability (ROA and ROE) and growth in revenue of public firms in
Germany. Only HCE and VAIC have a positive impact on employee productivity with the
impact being felt on the current year and one and three years later. SCE produced no
significant results.
Accounting values for intangible assets are of value relevance. The calculated intangible
value is a better measure of intangible assets compared to accounting values. Investors need
to consider the CIV to accurately value firms.
The results imply that in Germany, the relationship between intangible assets and firm value
can be best observed using the CIV as a measure of intellectual capital and balance sheet
recorded PPE. Profitability and labour productivity are better explained using VAIC, its
components and R&D expense.
Intellectual capital is a strategic asset in knowledge-economies. Complete and comparable
accounting for intangible assets still remain a challenge and the combined efforts of
accounting and legal practitioners, academics, market players, policy makers and business
leaders is needed to improve on the measurement of intangible assets.
In the meantime what policy makers can do is to encourage intellectual capital disclosure in
the form of intellectual capital reports to complement accounting statements.

48

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