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Intellectual capital reporting and its relation to market and financial performance
Mishari M. Alfraih,
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To cite this document:
Mishari M. Alfraih, (2018) "Intellectual capital reporting and its relation to market and
financial performance", International Journal of Ethics and Systems, https://doi.org/10.1108/
IJOES-02-2017-0034
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Intellectual
Intellectual capital reporting and capital
its relation to market and reporting
financial performance
Mishari M. Alfraih
Accounting Department, College of Business Studies,
The Public Authority for Applied Education and Training, Kuwait Received 26 February 2017
Revised 10 May 2017
Accepted 14 May 2017
Abstract
Purpose – This paper aims to examine the relationship between the level of intellectual capital information
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voluntarily disclosed in the annual reports of companies listed on the Kuwait Stock Exchange (KSE) and their
market and financial performance.
Design/methodology/approach – The classical framework developed by Sveiby (1997) and modified
by Guthrie et al. (2006) forms the basis for the content analysis of annual reports published by KSE-listed
companies in 2013. An intellectual capital disclosure (ICD) index is developed from this material. Two
traditional indicators of corporate performance, namely, market-to-book ratio and return on assets are used to
assess market and financial performance. Regression models are constructed to examine the association
between the level of ICD and corporate performance.
Findings – Empirical findings indicate that better ICD has a positive, statistically significant impact on
corporate performance. More specifically, the findings suggest that intellectual capital reporting plays a
significant role in enhancing market and financial performance.
Research limitations/implications – This study only focuses on intellectual capital information
disclosed in annual reports; other means of corporate communication were not considered. Nevertheless, the
annual report has stood the test of time as the best source of corporate disclosure.
Practical implications – Given the importance of intellectual capital reporting in enhancing corporate
performance, a practical implication of this study is to make managers aware of its positive and significant
effect on market and financial performance, which may encourage companies to develop better disclosure
policies. An important implication of the findings is that the policymakers and regulators need to encourage
listed companies to disclose their intellectual capital information to exploit the associated benefits.
Originality/value – This paper extends the literature by examining the influence of ICD on corporate
performance in the context of frontier markets, where economic, social, political and cultural conditions have
particular characteristics.
Keywords Kuwait, Corporate performance, Intellectual capital disclosure, Annual reports,
Financial reporting, Frontier markets
Paper type Research paper
1. Introduction
Although tangible assets such as property, plant and equipment continue to be significant
elements in the production of goods and services, their relative importance has decreased as
the relevance of assets such as intellectual capital (IC) has increased (Luthy, 1998). This
becomes particularly apparent when considering the dramatic shift from the industrial
economy, in which tangible resources dominate, to a new, knowledge-based economy in
which intangible, intellectual assets, such as IC, are key determinants of competitive International Journal of Ethics and
Systems
© Emerald Publishing Limited
2514-9369
JEL classification – M41, M42 DOI 10.1108/IJOES-02-2017-0034
IJOES advantage, economic success and value creation (Lev et al., 2005; Ellis and Seng, 2015). The
observation is supported by a report from the World Bank (2005), which reveals that IC
constitutes the largest share of wealth in virtually all countries, accounting for 77 per cent
worldwide. IC encompasses the knowledge, information, intellectual property and
experience that can be used to create wealth (García-Meca and Martínez, 2005; Branco et al.,
2010). Its intangible nature distinguishes it from the traditional resources that appear in
financial reporting (Branco et al., 2010; Mehralian et al., 2012).
The lack of a clear definition and measurement difficulties mean that IC assets are often
unreported in financial statements, although they may constitute up to 80 per cent of a
company’s market value (Cheng et al., 2010). Interestingly, even International Financial
Reporting Standards (IFRS) do not help in redefining many of the concepts, principles and
valuation methods of IC assets[1] (Zéghal and Maaloul, 2010). Although there is a lack of
consensus on its definition, the literature broadly defines it as the difference between a
company’s market value and its book value (Ordoñez de Pablos, 2003; Haji and Ghazali, 2013).
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At the same time, research has noted the gap between a company’s market value and its book
value (Chu et al., 2011), which is a concern for investors (Hurwitz et al., 2002). Hulten and Hao
(2008) argue that the US’ equity market consistently values shareholder equity at more than
twice the value appearing on traditional corporate balance sheets (in other words, the book
value). Similarly, Inkinen (2015) shows that the average company’s IC is estimated to be three to
four times its book value. Numerous observers have pointed to the absence of IC assets in
traditional corporate reporting as an important explanation for this phenomenon (Lev, 2001;
Chen et al., 2005; Hulten and Hao, 2008).
IC has attracted much research attention in the past 15 years (Chen et al., 2005; Whiting and
Woodcock, 2011), encouraged by claims that IC information could result in more-informed
investment decisions (Graaf, 2013). In 2015, Ernst & Young (EY) commissioned a study
exploring institutional investors’ views on IC asset reporting by publicly traded companies
worldwide. The study revealed that today, more than ever, institutional investors use
companies’ IC disclosure to inform and underpin their decisions. This view is understandable,
as there are an increasing number of examples where companies’ intangibles outvalue their
tangible assets [Ernst & Young (EY), 2015]. Similarly, Bismuth and Tojo (2008) argue that
providing the market with sufficient and appropriate information about intellectual assets
improves investors’ decision-making and helps to discipline management and boards, with
positive economic consequences. However, despite clear interest from the investor base, many
companies have yet to respond [Ernst & Young (EY), 2015].
The theoretical literature has suggested that IC has a positive impact on corporate
performance (Inkinen, 2015). For example, Gu and Lev (2011) argue that IC is a major driver of
economic growth and corporate performance in most economic sectors. Clarke et al. (2011)
claim that a company’s value is often partly based on its IC assets; therefore, the efficiency of IC
utilization has a direct influence on performance. Lin et al. (2012) put forward similar
arguments. Cuozzo et al. (2017) emphasize that more empirical research is required as there is
little supporting evidence for the theory (Wang and Chang, 2005), especially as current results
are mixed. Some studies have documented that IC has a positive impact on corporate
performance (see for example, Chen et al., 2005; Tovstiga and Tulugurova, 2007; Ting and
Lean, 2009; Cheng et al., 2010; Clarke et al., 2011; Massaro et al., 2015; Andreeva and Garanina,
2016; Martini et al., 2016), while others are inconclusive (see for example, Huang and Liu, 2005;
Kamath, 2007; Ghosh and Mondal, 2009; Maditinos et al., 2011; Dženopoljac et al., 2016).
Furthermore, most of the literature has focused on mature market economies, and there
are few studies in emerging and frontier markets. Kamath (2007) argues that the
implications of IC are greater in these economies, as they have abundant intellectual and
human capital at their disposal. Sukumaran et al. (2015) argue that, in contrast to developed Intellectual
market economies, frontier markets are smaller and less accessible and can be seen as a capital
subclass of emerging market economies. MSCI, a leading provider of global indexes,
currently lists 23 markets[2] in its frontier markets index, including Kuwait (MSCI, 2016).
reporting
This study therefore addresses these gaps in the IC literature and examines the claim that IC
is a driver for corporate performance in the frontier market of Kuwait. More specifically, it
empirically investigates the association between the extent of IC reporting by companies
listed on the Kuwait Stock Exchange (KSE) and two traditional measures of corporate
performance, namely, market performance and financial performance. The study draws its
theoretical foundations from the resource-based view to develop two hypotheses. The
findings help to assess the effectiveness of IC as a tool and identify opportunities for
potential improvements.
The remainder of this paper is organized as follows: Section 2 reviews the literature on
both IC reporting and corporate performance and develops the hypotheses. Section 3
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outlines the method. Section 4 presents an analysis of the data and the results of the study.
Finally, Section 5 presents the summary and concluding comments.
Other work has adopted agency theory (Jensen and Meckling, 1976) as the primary
framework (Albassam, 2014), which has been supplemented by signaling theory (Akerlof,
1970; Morris, 1987), stakeholder theory (Freeman, 1984), resource dependence theory (Pfeffer
and Salancik, 1978), proprietary cost and competition theory (Verrecchia, 1983) and capital
market theory (Choi, 1973).
Corporate annual reporting has proven to be the best source of disclosure (Cuozzo et al.,
2017). It is one of the primary ways in which companies communicate with stakeholders;
however, rapid changes in the broader business environment have increased concerns about
whether it continues to fulfill its objectives (Kriz and Blomme, 2016). The issue has become
particularly apparent in the new, knowledge-based economy where IC assets create value
and indicate a company’s future potential. Consequently, the value of a company can no
longer be accurately measured by the value of its physical assets, as demonstrated by
acquisitions (Arkblad and Milberg, 2006).
IJOES Hurwitz et al. (2002) contend that the main argument for the influence of IC on company
performance arises from the resource-based view. According to this view, IC consists of
information, intellectual property, intellectual material, knowledge, core techniques,
customer relationships and experience assets that are difficult to copy or substitute and
which can be used to create wealth (Inkinen, 2015). From this perspective, it can be viewed
as a powerful competitive weapon in business (Wang and Chang, 2005). IC is intangible and
can be thought of as a form of “unaccounted capital” in the traditional accounting system
(Abeysekera and Guthrie, 2005).
As highlighted above, there is no consensus on the definition of IC in the literature, but
three elements have emerged: human capital, structural capital and customer (relational)
capital (Wang and Chang, 2005). Riahi-Belkaoui (2003) highlights human capital as helpful
in innovating new products and services, in addition to enhancing business processes and
practices. Structural capital consists of the knowledge that belongs to the company as a
whole, in terms of inventions, strategies, technologies, data, culture, publications, systems,
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USA healthcare industry. Similarly, Joshi et al. (2013) confirm that value creation in the
Australian financial sector is highly influenced by IC. In the context of Luxembourg and
Belgium, Mention and Bontis (2013) confirm that human capital contributes both directly
and indirectly to performance in the banking sector. Finally, Nimtrakoon’s (2015) study of
listed companies in Indonesia, Malaysia, Philippines, Singapore and Thailand finds a
significant effect on market value and financial performance measures.
However, other results are mixed or negative. For example, using data from listed
companies in South Africa, Firer and Williams (2003) explore the association between
physical capital and IC and three traditional dimensions of corporate performance, namely,
profitability (returns on assets), productivity (turnover of total assets) and market value
(market-to-book value ratio of net assets). Surprisingly, they find a negative association.
Similarly, in Argentina, F-Jardon and Martos (2009) reveal that only structural capital
affects performance, while no effect was observed for human or relational capital. Mixed
results are documented by Ghosh and Mondal (2009) in India. Their empirical evidence finds
that IC can explain profitability (return on assets) but not productivity (assets turnover
ratio) and market valuation (market-to-book ratio). Maditinos et al. (2011), in Greece, and
Dženopoljac et al. (2016), in Serbia, fail to find support for the hypothesis that there is a
relationship between IC and market value or financial performance.
2.3 Hypotheses
In an era of knowledge-based resources, IC is a key determinant of competitive advantage,
economic success and value creation (Lev et al., 2005). The resource-based view argues that
companies can improve financial performance through the acquisition, holding and
subsequent use of intellectual assets (Ghosh and Mondal, 2009). IC represents value that is
difficult to copy or substitute (Hurwitz et al., 2002), while differences in performance can be
explained by differences in resource portfolios and how they are used (Mention and Bontis,
2013). As IC is clearly a critical resource that is expected to contribute to better performance
(Zéghal and Maaloul, 2010), more IC information disclosed in a company’s annual report
should represent a source of competitive advantage and thus lead to better corporate
performance. Despite the lack of consensus in previous work, this study predicts a positive
impact for KSE-listed companies. Specifically, the study predicts that higher IC disclosure in
a company’s annual report is consistent with better market and financial performance.
Therefore, the following hypotheses are developed:
IJOES H1. The level of voluntary, corporate intellectual capital disclosure is positively
associated with market performance, measured by the market-to-book ratio.
H2. The level of voluntary, corporate intellectual capital disclosure is positively
associated with financial performance, measured by return on assets.
(56) and real estate (36). The analysis focuses on annual reports for the 2013 fiscal year.
Although IC disclosure can take various forms, the annual report has stood the test of time
(Cuozzo et al., 2017). Campbell (2000) argues that this is because:
The company has complete editorial control over the content (except audited
financials).
It is public, free and widely distributed.
Reports were either downloaded from the official company website or the company was
contacted directly. Corporate performance measures and control variables were drawn
either from annual reports or the official KSE website (www.boursakuwait.com.kw).
MB is computed as the ratio of total market capitalization (share price multiplied by the
number of outstanding common shares) to book value of net assets. ROA is the ratio of net
income to total assets. Consistent with Firer and Williams (2003); Chen et al. (2005); Huang
and Liu (2005); Kamath (2008); Ghosh and Mondal (2009); Zéghal and Maaloul (2010); Chu
et al. (2011); Clarke et al. (2011); Maditinos et al. (2011); Joshi et al. (2013); Vishnu and Gupta
(2014); Nimtrakoon (2015); Dženopoljac et al. (2016), these two indicators are adopted here.
Kuwait.
The vast majority of disclosure studies adopt a dichotomous, item-based approach in
which an element scores one if it is disclosed and zero otherwise (Chavent et al., 2006).
Consistent with this approach and following Guthrie and Petty (2000), April et al. (2003),
Goh and Lim (2004), Li et al. (2008), Abeysekera (2010) and Haji and Ghazali (2013), in this
study each of the 24 attributes was coded. Scoring was based on a careful review of each
annual report. Once the actual score was obtained, the ratio of actual disclosure to the
maximum possible score of 24 was calculated as the Intellectual Capital Disclosure (ICD)
index.
Model 2 tested the relation between financial performance, ICD and control variables. It is
expressed as follows:
where:
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4. Empirical results
4.1 Descriptive statistics
Panel A of Table II presents descriptive statistics for dependent, independent and
continuous control variables. Mean MB is 1.10, ranging from 0.32–3.89. Mean ROA is
0.03, ranging from 0.25-0.23. ICD ranges from 0-96 per cent, with a mean of 28 per cent
and standard deviation of 22 per cent. Company size (total assets) varied significantly,
ranging from Kuwaiti Dinar (KD) 1.68 m to KD 18,600.14 m, with a mean of KD 207.45
m. As the distribution was non-normal, this variable was log-transformed. Mean
leverage was 37 per cent, ranging from 0.02-0.89 per cent. Panel B shows the analysis of
industrial sector.
Notes: *, **, *** Significant at # 0.10, 0.05 and 0.01 levels respectively (two-tailed). MB is the ratio of the
total market capitalization (share price times number of outstanding common shares) to book value of net
Table IV. assets for company i at time t; ROA is the ratio of the net income to the total assets for company i at time t;
Regression of market ICD is the intellectual capital disclosure index score; SIZE is the natural logarithm of the total assets of
company i at time t; LEV is the ratio of total debt to total assets of company i at time t; IND_FIN is dummy
and financial
variable that equals one for companies in the financial institutions category and zero otherwise; IND_INV is
performance dummy variable that equals one for companies in the investment category and zero otherwise; IND_MUNF
measures on is a dummy variable that equals one for companies in the industrial category and zero otherwise;
intellectual capital IND_SERV is a dummy variable that equals one for companies in the services category and zero otherwise
disclosure (the omitted industry category when all categories are zero is the real estate category); t = 2013 fiscal year
regressing ROA on ICD, after controlling for company size, leverage and industrial category.
This model was also significant (F = 4.73, p < 0.01) and explained about 18 per cent of
variation. This results is also consistent with earlier work (Chen et al., 2005; Zéghal and
Maaloul, 2010; Chu et al., 2011). Company size, leverage, investment and manufacturing are
not significantly associated with financial performance. In contrast, Financial institution
(p < 0.05) and services (p < 0.10) categories are significant.
Overall, the analyses support the hypothesis that ICD has a positive and significant
impact on corporate performance. In particular, the empirical results support the Hypothesis
(H1) that market performance, as measured by MB, is significantly influenced by ICD.
Similar support was found for Hypothesis (H2), namely, that financial performance, as
measured by ROA is significantly influenced by ICD. These results extend our
understanding of the role of IC information in frontier markets, with particular economic,
social, political and cultural characteristics.
5. Conclusion
This paper examines how voluntarily IC disclosure, as found in the annual reports of
companies listed on the KSE influences corporate performance. Drawing on the resource-
based view, it develops two hypotheses regarding the influence of IC information. The aim is
to assess its effectiveness as a tool and identify potential areas for improvement. Despite a
lack of consensus in previous studies, the study predicted a positive impact on KSE-listed
companies. Specifically, the study predicted that better disclosure in the company’s annual Intellectual
report is consistent with better market and financial performance. capital
An ICD index, inspired by the classical framework developed by Sveiby (1997) and
modified by Guthrie et al. (2006), provided the basis for a content analysis of the annual
reporting
reports published by KSE-listed companies in 2013. Consistent with prior studies, disclosure
is divided into three main categories:
(1) internal capital;
(2) external capital; and
(3) human capital.
and performance. These results provide empirical support for the theoretical prediction of
the influence of IC information on corporate market and financial performance.
This study contributes to the literature by presenting empirical evidence on the influence
of IC information on corporate performance, using data from KSE-listed companies. The
results extend knowledge on the role of IC reporting in capital markets, by broadening its
scope to include frontier markets. A practical implication is to make managers aware of the
positive and significant effect of IC information on performance, which may encourage
companies to develop better disclosure policies. An important implication is that the
policymakers and regulators need to encourage listed companies to disclose IC information
to exploit the associated benefits.
Although this study supports and complements the current literature and contributes to
the theoretical and empirical debate on the impact of disclosure, there are some
methodological limitations. First, it only examines annual reports. Future research could
investigate the disclosure of IC information in other corporate communications, such as the
company’s website, press releases, conferences and prospectuses. Second, it suffers from
the subjectivity that is inherent in the use of content analysis to score the level of disclosure,
which is a concern in this and prior studies. Several precautions were taken to increase
objectivity. Future research could investigate IC using the value added intellectual
coefficient method as an IC indicator. Third, time limitations meant that the sample
was limited to a one-year period. Future research could investigate changes in the
relationship between corporate performance and disclosure. Despite these limitations, this
study makes a significant contribution to the IC debate by examining its relation to
corporate performance in frontier markets.
Notes
1. Although the International Accounting Standards Board (IASB) regulates IC assets under
IAS 38 (Intangible Assets), IAS 36 (Impairment of Assets) and IFRS 3 (Business
Combinations), as clear as these standards may seem, they can be problematic to implement
(Arkblad and Milberg, 2006).
2. The 23 frontier market countries are: Argentina, Bahrain, Bangladesh, Bulgaria, Croatia,
Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Morocco,
Nigeria, Oman, Pakistan, Romania, Serbia, Slovenia, Sri Lanka, Tunisia and Vietnam (MSCI,
2016).
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Further reading
Oliveras, E., Gowthorpe, C., Kasperskaya, Y. and Perramon, J. (2008), “Reporting intellectual capital in
Spain”, Corporate Communications: An International Journal, Vol. 13 No. 2, pp. 168-181, doi:
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management”, Journal of Intellectual Capital, Vol. 1 No. 2, pp. 155-176, doi: 10.1108/
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companies: a longitudinal assessment”, Journal of Accounting & Organizational Change, Vol. 4
No. 1, pp. 67-80, doi: 10.1108/18325910810855798.
Vafaei, A., Taylor, D. and Ahmed, K. (2011), “The value relevance of intellectual capital disclosures”,
Journal of Intellectual Capital, Vol. 12 No. 3, pp. 407-429, doi: 10.1108/14691931111154715.
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