Stock analysts' assessments of the shareholder value of intangible assets
Introduction
Proponents of the resource-based view (RBV) of the firm point to the important role of assets in general and of intangible assets in particular (e.g., Barney, 1986, Barney, 1995, Conner and Prahalad, 1996, Grant, 1991, Hall, 1993). Intangible assets can comprise the majority of a firm's total assets (Doyle, 2000), are important contributors to shareholder value (Gupta et al., 2004), and provide a sustainable source of wealth creation (Riahi-Belkaoui, 2003). Intangible assets include brands, customer relationships, and market knowledge. The RBV suggests that intangible assets may be powerful sources of competitive advantage because rival firms cannot easily comprehend, evaluate, and imitate them. Intangible assets are also difficult to measure. The accounting profession struggles with the task of determining the financial value of intangible assets (Lev, 2001). Consequently, the more intangible-dominant the firm, the more likely its financial reports do not reflect the full potential of the firm's future returns on investment (see Choi et al., 2000).
Generally, each firm has the responsibility to measure and report upon the value of its intangibles. Because of the lack of regulated reporting controls (Guthrie and Petty, 2000), disclosure by firms of the perceived value of intangibles is irregular (Ambler et al., 2001), subjective (Backhuijs et al., 1999), selective (Wyatt, 2002), and informal (Stolowy and Jeny-Cazavan, 2001). Over-valuation of intangible assets was the principal cause of corporate crashes such as WorldCom and Enron in the USA, and HIH and One.Tel in Australia. Investor reaction to these unexpected crashes indicates an urgent need for investors to receive more accurate information about the nature and value of firms' intangible assets (Lim and Dallimore, 2002).
Because intangible assets are complex and difficult to measure (Srivastava et al., 1998), challenges exist not only for investors but also for the stock analysts who advise them. The role of stock analysts is a critical one: evaluating the tangible and intangible assets of firms and then making recommendations to investors based on their evaluations. The more accurately stock analysts evaluate a firm's intangible assets, the more likely they facilitate informed decision-making by investors by providing an accurate assessment of a key influencer of shareholder value.
Stock analysts present themselves to investors as independent, impartial, and expert, yet little is known about how analysts deal with the challenge of assessing intangibles. This paper aims to understand the factors that can influence the accuracy of stock analysts' assessment of the shareholder value of intangible firm assets. On the basis of qualitative data derived from in-depth interviews with 63 stock analysts, the paper integrates these factors into five propositions.
This study is important for the marketing discipline because intangibles often relate to marketing (McLaughlin, 2003). A growing theoretical literature shows that marketing assets provide a substantial contribution to shareholder value. However, what is not known is how, whether, and to what extent, stock analysts understand the contribution of marketing intangibles to shareholder value. This issue is part of a broader question, namely, how do those external to the organization value the contribution of marketing, broadly defined, to the organization's future prosperity? This study also sheds light on the thought processes of stock analysts, and how they conceptualize intangibles and determine the relative contribution of intangibles to future shareholder value vis a vis tangibles.
This article begins by defining key terms, outlining the stock analyst's role, and presenting the methodology used. Subsequently, the article merges insights from the extant literature and from in-depth interviews with stock analysts to develop several propositions relating to analysts' assessments of intangible assets. Finally, the article provides guidelines for future research and discusses the implications of the propositional framework.
Section snippets
Key considerations
Intangibles, knowledge assets, and intellectual capital are interchangeable terms. Each term refers to a claim to future benefits that does not have a physical or financial embodiment, such as a stock or a bond (Lev, 2001).
Research shows a significant and positive relationship between intangible assets and shareholder value, but this proposition rests primarily on an analysis of individual intangible assets. Studies include: brands and products (e.g., Ambler, 2002, Fernandez, 2002, Houston et
Method
The propositions reported below combine insights from the extant literature with insights from in-depth interviews with stock analysts. Madhavan and Grover (1998) recommend this composite approach to (1) gauge the relevance and face validity of propositional frameworks (see also Yin, 1989) and (2) ensure that managerial input is included in the theory building process itself. The authors of the present study spoke by telephone to 63 stock analysts from 40 randomly selected full-service
Regulatory effects
Intangible assets are off-balance sheet items (Lev, 2000). A publicly-listed firm, wishing to state the value of its intangibles, would need to provide a separate item in the annual report or a specific document. No regulatory guidelines currently enforce the frequency or the content of such information (Guthrie and Petty, 2000). Thus, analysts face the situation that some firms do provide information and some do not, which, in turn, makes it difficult to compare firms. Furthermore, firms that
Specialization effects
The time constraints facing analysts suggest that they would benefit from being focused. Another reason for a focussed approach is that the nature and relative importance of intangibles can and does vary significantly from one sector to another (Doyle, 2000). Analysts readily acknowledge this point. One analyst comments, “I think intangibles are arguably universally important to all companies in various sectors, at varying degrees, based on industry structures and competition. A detailed
Valuation models
Most analysts in the survey report using internally-programmed Excel spreadsheets to perform their valuations and assessments of intangible assets. The analysts operate on a variety of subjective parameters built up over a period of time. The parameters tend not to be intangible specific, with the intangibles formulae mixed in with other variables such as fixed assets and historical share performance. As a general rule, these valuation models are very basic, something reflected in the comment
Contextual effects
The analyst's challenge is not only to identify and assess the intangible assets of the firm, but to determine the likely contribution of intangible assets to the firm in dealing with a changing external environment. Barney (1995), one of the foremost proponents of the RBV, points to the need to integrate internal with external environmental analyses when evaluating the competitive advantage of firms. Recall that the first of the four questions referred to earlier asks whether a firm's
Capstone proposition
The final proposition extends the previous propositions. Analysts fail to apply to intangibles the sort of analytical rigor that they apply to tangibles. Analysts have limited notions of what intangibles are, and they have a limited understanding of the contribution of intangibles to shareholder value. Analysts have little interest in, and fail to keep abreast of, the present academic debate on the measurement and reporting of intangibles. These findings, in turn, raise serious doubts about the
Research directions and implications for managerial practice
The interviews confirm the validity of an unarticulated assumption in the extant literature (e.g., Gupta et al., 2004, Fornell et al., 2006): stock analysts do not, or cannot, fully comprehend the wealth generation capability of a firm's intangible assets and, for various reasons, partially or completely exclude them from their assessments and recommendations. However, to be overly critical of stock analysts is a mistake. The four critical questions the RBV poses to learn whether intangible
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