The value relevance of Intellectual Capital on the

firm’s market value: an empirical survey on the Italian

listed firms

Olga Ferraro‫ ٭‬and Stefania Veltri 1 P0F

Department of Business Administration , University of Calabria

87036, Arcavacata di Rende (CS), Calabria, Italy
E-mail: o.ferraro@unical.it
0TU U0T

E.mail: stefania.veltri@unical.it
0TU U0T

*Corresponding author

Abstract: The purpose of the paper is to investigate the value relevance of

intellectual capital of Italian listed firms. The paper applies the Ohlson model
(1995) to 524 firm-year observations of Italian listed companies for the three
year period 2006-2008 using a Panel econometric model. The findings show that
the fundamental variables of the Ohlson model (Book value and Earning) are
positively related to the market value. On the contrary, the IC variables, which
reflect Human Capital, Innovation Capital, Process Capital and Relation Capital,
do not have a meaningful relation with the market value, except for the last one.
Concluding, Italian investors do not seem to be able to detect and incorporate the
information on intellectual capital as represented in the IC proxies chosen for the
research into their business valuation process.

Biographical notes:
Olga Ferraro is actually researcher in Business Economics within the Faculty of
Economics of University of Calabria. Her main research interests are related to
value relevance analysis, the performances of companies and International
Accounting Standard. On these research themes she has published books, book
chapters, journal articles and presented papers to national and international
congresses.

Stefania Veltri is actually researcher in Business Economics within the Faculty

of Economics of University of Calabria. Her main research interests are related
to value relevance analysis, strategic and management control, the performances
of university systems, the systems of measurement intellectual capital. On these
research themes she has published books, book chapters, journal articles and
presented papers to national and international congresses.

1
For academic purposes, the paragraphs can be attributed as follows: par. 2, 3, 6,
8, 10 to Olga Ferraro, par. 1, 4, 5, 7, 9 can be attributed to StefaniaVeltri.
1
1 Introduction
Intellectual capital (IC), definable as the dynamic system of knowledge related
resources and activities, has become, in today’s knowledge-based economy, the primary
driver of the firm's value creation and hence of economic wealth of nations (Lev and
Zambon, 2003). This statement has its confirmation in a series of empirical researches
which have revealed the estimated contribution of intangibles to the market value (MV)
of firms (Lev, 2001; Kaplan and Norton, 2004).
The number of surveys on the relation between IC and firms market value increased in
the last few years and this phenomenon can mainly be attributable to data availability, to
the ease in accessing accounting data and firm’s income statement databases, to the
capacity of operative programs used by researchers to process a huge amount of data, to
the improvement of the econometric techniques used and to the development of better
ways to measure intellectual capital using accounting data (see Ante Pulic's VAICTM
index 1998, 2000, 2004). The major part of current researches recorded positive findings
in the IC/MV relation using VAICTM as IC measure. However, if there is a growing
literature showing that IC enhance firm valuation, it remains largely unknown if investors
price IC. It is necessary to conduct other researches on the value relevance of IC, on its
impact on the firm’s market value. We choose to test the IC value relevance through a
model based on the Ohlson model (1995). Several recent studies have documented that
the Ohlson model has a fairly good explanatory power (Barth et al 1999; Bernard, 1995,
Dechow et al. 1999) and, therefore, is appropriate for examining the association between
intellectual capital and firm's value (Kohlbeck and Warfield 2007).
The main aim of the article is therefore to test, through panel data regression
techniques, the impact of the firm’s IC, measured with accounting data, on the share price
on the Italian stock exchange market, by using a simplified version of the OM.
The article provides two contributions to the value relevance and IC literature. First,
the study is one of the first empirical researches that explicitly examines the value
relevance of IC in investors’ business valuation. This study also contributes to the
literature by providing evidence from a capital market which differs significantly from
that of the US, where the major part of research based on Ohlson model is concentrated.

2 Literature review and development of research hypotheses

The value relevance literature is a traditional current of accounting studies, where the
value of the firm is the accounting book value plus the present value of expected future
residual income (Burgsthaler and Dichev 1997; Cheng and McNamara 2000).
The most famous model in value relevance analysis is Ohlson model (1995). OM
relates a firm’s market value to basic accounting data and other kind of information. The
model relies on three basic assumptions (Dechow et al., 1999). The first assumption is
that market value (MV) of firm’s equity is equal to the present value of expected
dividends:
∞
Et [d t +τ ]
MVt = ∑ (1)
τ =1 (1 + r )
τ

where MVt is the market value of firm’s equity at time t, d is net dividends paid at time t,
r is the (assumed constant) discount rate or the cost-of-equity capital, Et[ ] is the
2
expected value operator conditioned on date t information. This assumption derives from
the dividend-discounting model (DDM), the traditional model for firm valuation (Miller
and Modigliani, 1961) which approaches the problem of firms evaluation from the
shareholder perspective.
The second assumption is referred as the clean surplus relation (CSR). According to CSR,
all changes to book value are reported as either income or dividends (Feltham and Ohlson,
1995):

bt = bt −1 + xt − d t (2)
The CSR assumption allows future dividends to be expressed in terms of future
earnings and book value. Combining the Eq (2) with the Eq (1), price can be rewritten as
follows:
∞
Et [bt +τ −1 + xt +τ − bt +τ ]
MVt = ∑ (3)
τ =1 (1 + r )τ
Simple algebraic manipulations allows to rewrite eq (3) as follows:
∞
Et [xt +τ − rbt +τ −1 ] Et [bt + ∞ ]
MVt = bt + ∑ − (4)
τ =1 (1 + r )τ (1 + r )∞
The final term in Eq (4) is assumed to be zero while the expression in brackets [ ] is
known as residual income or abnormal earnings. Book value at date t-1 multiplied by the
capital cost is considered “normal earnings” of the firm, thus earnings for the period t
minus "normal earnings' can be defined “abnormal earnings” (Ota, 2002)

xta = xt − rbt −1 (5)

Eq (4) can be rewritten as follows:

MVt = bt + ∑
∞
[ ]
Et xta+τ
(6)
τ =1 (1 + r )
τ

Eq. (6) is Residual Income (RI) version of DMM. The RI model implies that a firm’s
value equals its book value of equity and the present value of anticipated abnormal
earnings (residual income).
The third and final assumption is referred to “Linear Information Dynamics” (LID).
Originally proposed in Ohlson (1995) and Feltham and Ohlson (1995), the LID is an
information dynamic model which assumes that the time series behaviour of abnormal
earnings satisfies the following modified autoregressive process AR (1):

bta+1 = ωxta + vt − ε 1t +1 (7a)

vta = γvt + ε 2t +1 (7b)

where ν is information other than abnormal earnings, and ω and γ are fixed persistence
parameters that are non-negative and less than one ε1 and ε2 represent the stochastic
errors assumed to have normal distribution and mean zero. uncorrelated with other
variables in the model.
3
 The original empirical applications of Ohlson model (Ohlson, 1995; Lundholm, 1995;
Dechow et al., 1999) depend on the third assumption, since Ohlson solved the problem
related to the difficult task of observing future expectations. This produces a closed
valuation formula, in which value depends solely on known accounting information plus
the ‘other information’ variable.
Combining Eq. (6) with Eq (7a) and Eq (7b), MV can be rewritten as follows:

MVt = bt + α1 xta + α 2vt (8)

3 Ohlson model (1995): theoretical and empirical evidences

Ohlson model (1995), hereafter OM (1995), has become the main reference model in
market-based accounting research. Its main contribution is that it provides a solid
theoretical framework for stock valuation based on the fundamental accounting variables:
earnings and book value and, in addition, it allows for any other information which could
be relevant to predict these figures and hence the value of the firm.
Nevertheless, OM (1995) is a simple model. It assumes that investors are risk-
neutral, accounting is unbiased, clean surplus always holds, there is no role for detail in
accounting, no information asymmetries exist, tax rates faced by shareholders are
irrelevant, real option are not explicitly taken into account, abnormal earnings and ‘ν’
evolve in an autoregressive manner. From a theoretical point of view, Ohlson himself
issued articles after 1995, for taking into account crucial interactions of key variables left
outside the baseline models like interactions between growth and conservative accounting
(Feltahm and Ohlson 1995, 1996, Gode and Ohlson 2005). Other authors focused on the
question of firm-specific risk (Gebhardt et al. 2001), information asymmetry (Hand and
Landsman 1999), detail in accounting (Barth et al. 1999), taxes (Collins and Kemsley
2000; Harris and Kemsley 1999), real options (Yee 2000) the time-series properties of
abnormal earnings (Dechow et al., 1999) and the linearity of function (Yee, 2000).
From an empirical point of view the question is under what circumstances a model
that takes care of all this improvements fits the data significantly better than does the
Ohlson (1995) baseline (Hand 2001). A recent research highlighted that models based on
OM (1995) explains stock prices better than those based on Feltham and Ohlson model
(1995), since they have lower bias and higher accuracy (Giner and Iniguez 2006b).
Researches on OM (1995) focused as well on empirical tests able to demonstrate the
model’s validity. Researchers tested OM (1995) and its following versions widespread.
Most of the literature refers to the USA (Baumann 1999; Myers 1999; Dechow et al.
1999; Callen and Morel 2001); exceptions are the studies of McCrae and Nilsson (2001),
Ota (2002) and Giner and Iniguez (2006a), that consider the Swedish, Japanese and
Spanish markets respectively.
In order to use OM (1995) within a regression model addressed to prove a causal
relation between accounting variables and firm’s market value, researchers modified the
Eq. (8) as follows:

MVt = β 0 + β1bt + β 2 xta + β 3vt + ε t (9)

with respect to the Eq. (8), in the Eq. (9) it has been added an intercept term (β 0 ) and
a residual term (ε), with the function to catch the price’s variations not explained by the
right side equation variables, a coefficient to the b t variable and the α 1 and α 2 coefficients
have been substituted by the β 1 and β 2 coefficients, on which is focused the attention of
researchers.

4
 In proving the existence of relationship between accounting variable and firm’s
market value, researchers further simplified the equation (9) by substituting the abnormal
earnings, hard to estimate, with net income (x t ) and setting ‘ν’ to zero (or assuming it to
have effects that are entirely absorbed in the intercept). They also use data scaled on a
per-share basis which provides the natural starting point (Ohlson, 2000). After these
further simplifications, the equation (9) became the following:

Pt = β 0 + β1BVPSt + β 2 EPSt + ε t (10)

This modified version has been widely used (Aboody 1996; Amir 1996; Amir and
Lev 2001; Collins et al. 1997; Barth et al.,1999). The following paragraph is dedicated to
the relevance of the ‘ν’ variable under a financial profile and to impact of its absence
from the regression analysis addressed to prove a relation between historical and forward
accounting variables and firm’s market value.

4 The ‘other information’ variable in the Ohlson model

The real contribution of OM (1995) comes from his modelling of the LID (Dechow
et al. 1999; Lo and Lys 2000). The difficulty concerning the empirical tests of Ohlson
model lies in identifying ‘ν’, which denotes information other than abnormal earnings that
has yet to be captured in current financial statement but affects future abnormal earnings.
Some authors omitted ‘ν’ from the regression equation when they are tested Ohlson
model, or assumed to be a constant because it is unobservable but this is not a solution,
since as a result, the ‘ν’ variable is absorbed in the error term, causing positive serial
correlation so violating one of the Gauss-Markov assumptions of the multiple regression
model (Ota 2002). In other words, omitting ‘ν’ from empirical specification of the OM
may yield highly misspecified inferences on the coefficients of the regression (Ohlson
1995; Hand and Landsman 1998). From a theoretical point of view, setting ‘ν’ to zero
assumes that current information on book value and net income are completely sufficient
for equity valuation or, that is the same, the only accounting information present in the
regression function capture value-relevant information with no lag. Ohlson, in his 1995
article, define ‘ν’ as a scale variable, but he does not concretely establish the analytical
content of the ‘other information’ variable. The lack of definition of the ‘ν’ variable
caused many researchers to neglect its use in the test of the model. Hand (2001)
highlights that up to 1998 almost all empirical researches on Ohlson models disdained the
informational content of ‘ν’. The few articles (among others Amir and Lev 1996; Myers
1999; Dechow et al. 1999) did not leave aside the variable ‘other information’ chose an
intuitive path instead of a formal construction; for instance Amir and Lev developed a
proxy for ‘ν’, using various items of non financial information in the wireless
communication industry, Myers choose as proxies new patents, approval of laws for a
new medicament in pharmaceutical companies, long term contracts among others.
Dechow et al. (1999) view the unspecification of the ‘ν’ variable as a major limitation of
the OM. Ohlson intervened in the debate on the ‘ν’ variable suggesting researchers can
use analysts’ earnings expectations combined with current accounting data to infer the
variable that relates to other information (Ohlson, 1998). He intervened again in 2001
(Ohlson, 2001), making clear that ignoring ‘ν’ reduces the empirical content of the model
and that there is no reasons to eliminate ‘ν’ from the model since the variable can be
based on observable data, such as forecasts of analysts, even if Ohlson referred to the
variable ‘other information’ as a ‘mysterious’ variable.

5
5 The intellectual capital as the ‘other information’ variable in the Ohlson
model
Coherently with the literature stream that believes ignoring ‘ν’ severely reduces the
model’s empirical content (Ohlson, 2001; Hand, 2001; Dechow et al., 1999), our paper
focuses on capturing ‘ν’, expression of expected future accounting data. In our opinion,
analysts forecasts, with their biases and noises, are not the most efficient statistics for ‘ν’
(Hand, 2001), and coherently with it, we believe that intellectual capital (IC) can express
the major part of expected future accounting data and that information on IC are value-
relevant to the investors with reference to the expected future accounting data (Yu et al.,
2009). In fact, recent studies have shown that intangible assets are significantly associated
with future earnings (Aboody and Lev 1998; Goodwin and Ahmed 2006; Lev and
Sougiannis 1996) and have been emphasized by analysts in making their forecasts
(Barron et al. 2002; García-Meca and Martínez 2007).
There is still no universally accepted definition of IC (Zambon 2003). It is a really
complex object of study, still being defined and constantly evolving. IC’s main features
are the dynamicity and firm-specificity, that is to say the elements which compose the IC
change constantly with time and vary in relation to the firm’s size, industry etc. The
notion of IC is also a transversal one; scholars who focused their interest on intangibles
deal with the IC theme in relation to those interests focusing from time to time on
different aspects functional to their analysis. IC literature is full of IC definitions (for a
comparison see Tan et al. 2008). Although IC definitions are different, all of them include
the notion of knowledge and link the intangibles with the firm’s value creation. However,
researchers and IC practitioners need a working definition of IC. From the second half of
the nineties numerous scholars (Bontis 1996; Edvinnson and Malone 1997; Stewart 1997)
started to present schemes able to help a conceptualization of IC and to present the IC
notion in a form usable for research. These schemes, with slight differences, tend to
converge greatly. The different authors, far from considering the IC a monodimensional
construct, agree with the consideration that IC can be found on different levels in the
firm; for this reason it does not have to be constrained to the knowledge held by
individual, but also has to include knowledge stored within organizational databases
business processes systems and relationships. A scheme that has greatly influenced other
researchers is that of Edvinsson and Malone (1997). According to them, IC is composed
of two main components, human capital (the knowledge. skills competencies and
experience of employees) and structural capital (the embodiment empowerment and
supportive infrastructure of human capital) in turn divided into organizational capital (the
systems tools and operating philosophy that speed the flow of knowledge through the
organization) and customer capital (relationships a company has with its customers).
Stewart (1997), in a similar way, defines the IC as composed of human capital, structural
capital (which includes the organizational one) and customer capital placed on an equal
footing with the other two. Bontis (1996) introduces the notion of relational capital as an
extended version of customer capital which includes the value of all a firm’s external
relationships.
IC is a dynamic and complex subject of study and IC definitions and frameworks are
constantly evolving. A number of IC definitions and frameworks, designed to better
classify and study the elements of IC, have been developed (Tan et al., 2008). Some of
the popular frameworks the balanced scorecard by Kaplan e Norton (1992), the intangible
asset monitor by Sveiby (1997), the Skandia value scheme by Edvinnson and Malone
(1997), the four categories of knowledge resources (employees, customers, processes and
technologies) by Danish Guidelines (2000) and, more recently, the concept of Knoware
tree which, with four perspectives (wetware and netware for stakeholders knowledge
assets and hardware and software for the structural knowledge assets), can be considered
6
the evolution of the traditional tripartition of IC in human, structural and relational capital
(Lerro et al., 2005; Schiuma et al., 2007; Schiuma, 2009).
These frameworks have been developed independently and at different times over the
past decade. We refer to Roos et al. (1997) to classify these different frameworks into two
different stream of thought: the strategic stream, which is about classifying IC and its
creation, management and utilization, and the measurement stream, which is about
measuring and reporting of IC. For our purposes, we need to refer to a measurement
framework.
We choose to use the more known IC framework, validated by academic literature
(Edvinsson and Malone, 1997; Stewart, 1997; Bontis, 1996) and by supranational
organisms (OECD, 1999) and European projects (IFAC, 1998, Meritum, 2002; HLEG,
2003), that divide IC into Human Capital (HC), Structural Capital (SC) and Relational
Capital (RC), because it is a working definition with the further practical dimension that
the components of IC may be assigned an economic value, which serve as a proxy for
measurement purposes.
In more details, human capital refers to the knowledge, skills and competencies of
people in an organization. Numerous studies have emphasized the importance of human
as a key component of intellectual capital (Ulrich, 1998; Davis and Noland, 2003). It is a
kind of capital which is not the property of the firm, so the company needs to enforce the
link with its workers as well as needing to find ways to transform the tacit knowledge in
structured knowledge. Examples are innovation capacity, creativity, know-how and
previous experience, teamwork capacity, employee flexibility, tolerance for ambiguity,
motivation, satisfaction, learning capacity, loyalty, formal training and education.
Relational capital is the totality of relations between firms and its main stakeholders.
Examples of this category are image, customer loyalty, customer satisfaction, link with
suppliers, commercial power, negotiating capacity with financial entities, environmental
activities, etc (Bontis, 1998).
The structural capital is the infrastructure that firms develop to commercialize their
intellectual capital (Edvinsson and Sullivan, 1996; Stewart, 2000). While firms do not
own human capital (Cohen and Kaimenakis, 2007), structural capital belongs to the
organization as a whole. It can be reproduced and shared. A good structural capital will be
provide a good environment for rapid knowledge sharing, collective knowledge growth,
shortened lead times and more productive people (Stewart, 2000).
In order to highlight the relative contribution of the different components of the
intellectual capital, we choose, following authors like Edvinnson and Malone (1997) and
Joia (2000), to divide structural capital into two different categories, process capital and
innovation capital. The Process Capital (PC) is an organization’s processes, techniques,
systems, and tools. Investors usually regard the quality of internal processes as an
important valuation factor (Mavrinac and Siesfeld, 1998). Therefore, firms should
maintain smooth and flexible operation processes to achieve process quality and
efficiency. The Innovation Capital is the capability of an organization to innovate and to
create new products and services. The main component of this category is represented by
R&D (Lev, 2001). The previous research has found that R&D plays a key role in a firm’s
innovation activities, representing future growth opportunities (Bae and Kim, 2003;
Bhagat and Welch 1995).

6 Research hypotheses
On the basis of the OM literature review, the first group of research hypotheses
concerns the value relevance of accounting variables for investors. In detail, the first two
research hypotheses are the following:

7
 H1: the firm’s market value is positively correlated with its book value
H2: the firm’s market value is positively correlated with its earnings
The question of the determinants of a company’s performance is one of the central
themes of strategic management studies (Galbreath and Galvin, 2008). Over the last two
decades this theme has undergone a major shift in focus, from industry-specific to firm-
specific factors (Hoopes et al., 2003). Thus, two competing theories dominate the
strategic management field today. The former theory, developed within the industrial
economy paradigm, hypothesizes that performance variations are due to structural
differences in the industry to which the firm belongs, and it is best represented by Porter’s
(1980) five forces model. The newest theory identifies the performance drivers with firm-
specific factors and it is best represented by the Resource-Based View (RBV), a term
coined by Wernerfelt in 1984 (Acedo et al., 2006). The firm is seen as an aggregate of
mutually interdependent tangible and intangible resources. Only valuable, rare,
imperfectly imitable and substitutable resources are able to generate sustainable
competitive advantages. Intangibles, for their peculiarities such as high barriers to
competitive duplication, scalability, increasing scale returns, and the net effect (Lev,
2001), respect all the conditions prescribed by the RBV to the resources able to generate a
sustainable competitive advantage (Barney, 1991; Galbreath, 2005). A recent research of
Galbreath and Galvin (2008) compared the effects of firm-specific (resources) and
industry-specific factors on the performance variations, proving that, as hypothesized by
scholars of RBV, unlike tangible resources, only intangible assets and capabilities are
able to explain the company’s performance variations.
On the basis of the IC literature review the second group of research hypotheses
concerns the value relevance of IC information for investors.
In detail, the other research hypotheses to test are the following:
H3: firm’s market value is positively correlated with its human capital
H4: firm’s market value is positively correlated with its innovation capital
H5: firm’s market value is positively correlated with its process capital
H6: firm’s market value is positively correlated with its relational capital
Recent studies highlighted that human capital, considered the primary source of
sustainable competitive advantage, can only have an indirect effect on the firm’s value, by
interacting with the other IC components (Bontis, 2008; Cabrita and Bontis, 2008, Cabrita
et al., 2007; Vali, 2008). In other words, human capital is thought to have a moderator
effect on the relation between innovation capital, process capital, relational capital from
one hand and the firm’s market value from the other hand.
Taking into account recent studies on the indirect effects of human capital (HC) on
firm’s value and on the existence of interaction effects between IC subcategories, we test
two further final research hypotheses:
H7: HC moderates the relation between innovation capital and firm’s market value
H8: HC moderates the relation between process capital and firm’s market value
H9: HC moderates the relation between relational capital and firm’s market value

8
7 Research Design: the model
In order to demonstrate that intellectual capital information is value relevant to
companies business valuation, in this paper we regress the use a simplified version of the
first Ohlson model (1995). Like the major part of researchers, we use the Eq. (10) but,
unlike them, we do not ignore the ‘other information’ variable, identifying it with the
information on intellectual capital, as Swarz et al. (2006), Wang (2008), Yu and Zhang
(2008), Yu et al. (2009).
The OM modified used in the research is the following:

Pt = β 0 + β1BVPSt + β 2 EPSt + β3 IC + ε t (11)

where IC = intellectual capital indicators of the firm.

As the model is essentially predictive using historical information, a problem of leads
and lags is present for the dependent variable P, therefore share price is taken some
months after each company’s fiscal year end, in order to give investors time for the
analysis of financial statements. Therefore, consistent with prior studies (Yu et al. 2009;
Swarz et al. 2006), we use firm i’s value of the common equity at the end of March in
year t+1 (denoted by Pt+3) as the dependent variable.
Following prior studies implementing Ohlson or versions of it, we measure variable
BVPS by firm i’s book value of equity per share at the end of year t and variable EPS by
firm i’s earning per share at the end of year t. In the following we explain and discuss the
proxies we choose to capture each component of intellectual capital. In this study, Human
capital (HC), Relation Capital (RC), Innovation capital (IC) and Process capital (PC) are
selected to reflect the multidimensional nature of IC (Marr, 2005). Following Sveiby’s
advice (2003), we kept at minimum the number of IC indicators for each category, in
order to keep the measurement system simple, providing at the same time a meaningful
picture and a valuable feedback.
Several methodologies for measuring IC have been developed. These measuring
techniques are still evolving. Studious like Luthy (1998), Williams (2000) and Sveiby
(2002) attempted to categorise these various methods into different approaches, but
broadly we can group measurement methods into two group, namely “non-dollar
valuation of IC” and “dollar valuation of IC” (Tan et al., 2008).
Between the most famous “non-dollar valuation of IC” measurement methods we can
quote the Balanced Scorecard by Kaplan and Norton (1992), the Skandia navigator by
Edvinssson and Malone (1997), the Intangible asset monitor by Sveiby (1997), the IC-
index by Roos et al. (1997) and, more recently, the IC statement by Mouritsen et al.
(2002) and the Regional Intellectual capital index (2008) by Schiuma et al. (2008).
Between the most famous “dollar evaluation of IC, the market-to-book value comparison
(Stewart, 1997; Edvinsson and Malone, 1997), the economic value added (EVA), the
Tobin’s q method, the Value Added Intellectual Coefficient (VAICTM) by Pulic (1998,
2000) and various accounting models, like human resource costing and accounting by
Joahnson and Grojer (1998), the Accounting for the future (AFTF) by Nash (1998), the
Total Value Creation (TVCTM) by McLean (1999) and the Value ExplorerTM by
Andriessen and Tiessen (2000).
To test the value relevance of intellectual capital we choose to measure IC by using a
“dollar valuation method of IC”, and particularly we choose to refer to accounting
measures. We choose to do not use any of the known methods, and, notwithstanding the
increasing popularity of the VAICTM method, we choose to do not use this method to
measure IC because of the limitations inside its calculation, mainly the distortion of
value-creation effect of structural capital for the overestimation of human capital impact
and the significant correlation between human capital and structural capital, that results in
9
multicollinearity in regression analysis and, in turn, reduces the creditability of the
research conclusions (Yu and Zhang 2008). Instead, we choose to use accounting proxies
for each IC subcategory, since we needed some empirical available and measurable
proxies in order to best capture the firm’s IC. All IC proxies are on a per-share basis, in
order to have homogeneous variables (scaling technique).
The choice to specify ‘ν’ by using various accounting information is also found in the
papers of Myers (1999), Hand and Landsman (1999) and Barth et al. (1999). The selected
proxy variables for these four IC dimensions (HC, PC, RC, InC) are supported by
previous academic research in IC measurement as shown in Table 1.
Table 1 – Proxy variables for IC multidimensional measurement
IC dimension Proxy variable Previous Research supported
Salaries and benefit expenses/N° of Pulic, (1998); Van Buren (1999); Swartz
Human Capital
shares et al. (2006)
Relation Capital Sales/N° of shares Van Buren (1999); Yu and Zhang (2008)
Selling, General & Administrative
Process Capital Van Buren (1999); Yu and Zhang (2008)
expenses/ N° of shares
Innovation Capital Intangible assets/N° of shares Yu and Zhang (2008)

In order to obtain normal distribution across all variable values (e.g.

homoscedasticity), as suggested by Easton (1999), the amount of company asset has been
added to the linear equation (Wang 2008).
All estimates include annual dummies in order to control for shocks in economy.
After these specifications, the equation used in the study is the following:
Pi ,t + 3 = β 0 + β 1 BVPS i ,t + β 2 EPS i ,t + β 3 e + β 4 HC i ,t + β 5 RC i ,t + β 6 PC i ,t + β 7 InC i ,t +
EPS i , t
(11)
+ β 8 HC i ,t xInC i ,t + β 9 HC i ,t xPC i ,t + β 10 HC i ,t xRC i ,t + β 11 Asset i ,t + d 1 + d 2 + ε i ,t

The equation (12) inserts the EPS variable at two levels. The exponential level has
been included in the equation because, as we will see in the fifth section, the relation
between price and EPS in Italian market showed, from a scatter plot graph, a exponential
pattern.
Table 2 summarizes symbols and definition of variables of model.

Table 2 – Research variable measures

Symbol Variable definition
Pi,t+3 Market value (or stock price) per share of i company at year + 3 month
BVPSi,t Book value per share of i company ‘s equity at time t
EPS i,t Earning per share of i company at time t
eEPSi,t The exp of EPS of i company at time t
Asset i,t Total asset value per share of i company at time t
HC i,t Salaries and benefit expenses per share of i company at time t
RC i,t Sales per share of i company at time t
PC i,t Selling, General & Admin. expenses per share of i company at time t
InC i,t Intangible assets per share of i company at time t
HCxInC The interaction term between HC and InC
HCxPC The interaction term between HC and PC
HCxRC The interaction term between HC and RC
d1 Dummy variable, year 2007
d2 Dummy variable, year 2008

10
8. Research design: the sample selection process
The study is focused on Italian context. The selection of the Italian context is
important because of the significance of testing such a factor in a financial market
considered not well functioning (if compared with English or American one),
characterized by a scarce diffusion of ad hoc documents used by companies to report
their intellectual capital (the so called IC reports) and a lower maturity of investors, if
compared with the benchmark English and American exchange markets (Guatri and Bini,
2005). Moreover, the consideration that this is one of the first research on the Italian stock
exchange market from an IC perspective is relevant, because it is important to achieve
greater understanding of the development of IC in different socio-political and economic
settings (Swarz et al., 2006). We choose to take into consideration all the companies
listed because, even though IC is important for knowledge-based companies inevitably it
has become essential in all companies. Nevertheless, companies belonging to the financial
sector have been excluded. The exclusion of the financial sector is justified by the lack of
homogeneity in the accounting data.
The populations for this study therefore consisted of the Italian companies listed on
the Milan Stock Exchange, excluding the financial sector, in the period 2006-2008. We
started with our survey from the 2006 because this period coincides with the complete
application of IAS/IFRS from all the of the Italian companies listed and, therefore, it
allows us to have a homogeneity in the observed values from an accounting point of view.
The values relating to book value per share (BVPS), earning per share (EPS), stock
price (P) and IC proxies were extrapolated from the Datastream database. After retrieving
573 firm-years observations for 191 Italian companies in the period 2006-2008,
inappropriate observations lacking variable information were deleted. The final sample is
therefore constituted by 524 observations (189 firms) as shown in table 3.

Table 3 – The sample selection process

Sample selection Initial sample Final sample
Total firm-years observations 573
With incomplete data 49 524

9. Regression analysis
In order to test the H1-H9 hypotheses, we use a research model, based on Ohlson,
that examines both the main and indirect effect of IC on firm’s value market, together
with accounting variables.
Since we use longitudinal or panel data (the sample contains observations for N firms
in T years), the regression has been carried out using models created ad hoc for panel
data, to take into consideration the heterogeneity of the individuals (firms in our case) 1.
In our sample we hypothesize that FE panel is the right model. The Hausman test,
carried out with Stata program, confirms our hypothesis.
The table 4 shows the results of the panel data least square regression.

1
In the panel models, the error component is composed by two terms: the individual heterogeneity (αi) and the
stochastic term (εi). The assumptions about the αi term affect the estimation method: if individual effect is
thought to be a fixed parameter and it is allowed correlation between individual effect and explanatory variables,
then fixed effects (FE) models have to be used, otherwise, if the individual effect is a random variable and it is
not allowed correlation between individual effect and explanatory variables, then random effects (RE) are
appropriate models.
11
 Table 4 – The coefficients of multiple regression
Variable Coefficient t-value
Intercept 8.0585 3.34***
BVPS 1.3610 2.10*
EPS .2579 0.40
eEPS .0228 3.72***
HC -.4612 -2.56*
InC -.0415 -0.20
PC -.8421 -2.19*
RC .0462 2.64**
HCxInC -.0053 -1.17
HCxPC .0205 2.32*
HCxRC .0002 0.35
ASSET -.0655 -0.94
R2 0.52
F 300.04***
* p-value<0.05; **p-value<0.01; ***p-value<0.001

Analysing the results of the regression, we can note that the variable EPS has been
included at two levels. The choice to include the exponential of EPS is due to the
presence of a non linear relation between the price and the EPS, highlighted by a scatter
plot graph. In order to test the conjoint significance of the EPS terms, a Wald test has
been conducted (p<0.0001). After this adjustment, we can conclude that H1 and H2 are
fully supported. This result is not obvious, since many researchers do not find any
significance in the Beta-coefficients of the BVPS and EPS (Wang, 2008).
With relation to the main IC effects on the firm’s market value, we tested H3-H6
hypotheses. With relation to H3, no support was found. The HC coefficient is significant,
but not in the predicted direction. This result may capture the stock market’s view that
higher salaries and benefits signal weaker HC value. In relation to the H4, the hypothesis
was not supported. A possible reason is that market participants consider negatively
companies’ innovation investments because the outcomes of these innovations are usually
unpredictable (Barker 1999; García-Meca and Martínez 2007). Another reason could be
the R&D expenses, that are the best proxy for InC, are not available for all companies
included in the sample, we fall back on intangible assets to measure innovation capital.
With relation to H5, the hypothesis was not supported. The PC coefficient is significant,
but not in the predicted direction. This result may capture the investors’ view that higher
general administrative expenses weaken PC value. With relation to H6, the hypothesis is
supported, probably because sales volumes reflects the firm’s market share and the
customer loyalty (Kaplan and Norton, 2004). It is easy to note that the proxies based on
“negative” accounting values (i.e. costs) are not perceived by investors as investments,
rather they are perceived as empty costs; instead proxy based on “positive” accounting
values, as for relational capital, are positively evaluated by investors.
With relation to the HC interaction effects on the firm’s market value, we tested H7-
H9 hypotheses. Starting from a HC coefficient significant but not in the predicted
direction, we were not confident of achieving reliable results. The regression results
return a significant role played by HC in the relation between PC and firm’s value, but not
in that one that involves InC and RC on one hand and firm’s value on the other hand. In
summary H7 is supported, while H8 and H9 are not supported.
The R2 of the model is .52, which means that 52 percent of stock price variation can
be explained by the variables of our model. F value (300.04) is significant (p< 0.001).
Similar mixed results have been achieved by other researchers who tested the same
relation: Yu and Zhang (2008) find significant coefficients for HC, partially significant
for RC, inconsistent for InC; Swarz et al. (2006) find significant coefficients for HCE
12
(Human capital efficiency) and inconsistent results for SCE (structural capital efficiency,
which includes relational capital and structural capital); Wang finds all coefficients
significant, but not in the predicted, positive, direction, while Yu et al. (2009) find
significant coefficients and in the predicted direction for HC and PC, significant
coefficients but not in the predicted direction for RC and inconsistent coefficients for InC.

10 Concluding remarks and suggestions for future research

We run a panel regression in order to test the impact of the IC’s subcategories
(human capital, relational capital, structural capital, innovation capital) on the share price
within the Italian context. We hypothesized a positive relationship between each IC
subcategory and the market value. The analysis considered both the main and indirect
effects of IC on firm’s market value. We derived our IC’s subcategory measures from the
accounting data. In order to test our hypotheses, we use a model based on the OM, the
most famous model of the value relevance theory, aimed to test the value relevance of an
accounting value.
The results of our research show that, within the Italian context, the basic accounting
variables (BVPS and EPS) are value relevant for investors. With relation to the main IC
effects, it seems that investors price only relational capital and recognize a moderator
effect to the HC only when it interacts with PC.
The inconsistent results for the IC could have many possible reasons:
1) the inadequacy of the accounting proxies selected to identify the IC subcategories;
2) the imperfect functioning of the Italian market (Guatri and Bini, 2005)
3) the low degree of investor awareness, e.g. inability to “read” the accounting
information from an IC perspective.
Among the research’s limits we must underline the unavailability of data, which
obliged us to fall back to other less efficient proxies (intangible assets instead of R&D
expenses to proxy InC) for the lack of a considerable number of values. Another limit is
linked to the lack of a recognized and validated research framework for detecting the IC
values from an accounting perspective. We based our IC proxies on previous studies on
the relation between IC and market value, which do not constitute a complete dataset.
In conclusion, our results imply that investors do not seem to be able to detect and
incorporate intellectual capital information as represented in the IC proxies chosen for the
research into their business valuation process. In future, the model could be tested by
using different and more effective proxies for IC. Moreover, the research could be
extended to other countries, in order to test for the moderating role of financial markets
and could be enlarged to a more extended period of time.
The major contribution of the paper is that it represents one of the few studies that
has explicitly examined the value relevance of intellectual capital in investors’ business
valuation process. Nevertheless the results could be even more instructive if in the future
the accounting normative required the disclosure of the intellectual capital and its
components in the notes of financial statements. This will give rise a huge and
standardized data set that will allow researchers to examine more effectively whether and
at what extent investors value intellectual components.

13
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