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What is a Company Really Worth? Intangible Capital and the "Market to Book Value" Puzzle
Somehow missed this when it came out. Data isn't surprising but we must keep beating the drum to get this message out:
What is a Company Really Worth? Intangible Capital and the "Market to Book Value" Puzzle
Charles R. Hulten, Xiaohui HaoNBER Working Paper No. 14548* "What is a company really worth?" is a question asked repeatedly during the recent financial crisis. Attention has been focused on short-term valuation issues, like the "mark-to-market" controversy. Sorting out these issues is complicated by the fact that the market puts a value on shareholder equity that is consistently more than twice the reported book value of a company. Numerous observers have pointed to the absence of most intangible assets from financial statements as an important source of this puzzle. We use Compustat financial data for 617 R&D intensive firms to test this possibility. We find that conventional book value alone explains only 31 percent of the market capitalization of these firms in 2006, and that this increases to 75 percent when our estimates of intangible capital are included. The debt-equity ratio also falls from 1.46 to 0.61. These findings suggest that financial reports tend to substantially understate the long-run intrinsic value of corporate America. You can find this paper here: http://www.nber.org/papers/w14548 |
Tags: America, capital, corporate, intangible, intellectual, value
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Replies to This Discussion
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Permalink Reply by Mike Healy on -
Mary,
I am brand new to this group.
I am interested in the impact of intangibles on company valuation and what can be done to "beef up" the intangibles to make a company more atttractive to a buyer. I am particularly focused on human capital.
Any recommendations re: materials, checklists, tools spcifically focusing on this area.
Mike
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Permalink Reply by Mary Adams on
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Mike- We have a discussion that would be a good starting point but there is lots more to say on this. In fact, I think this could be a whole group within the community. Take a look and then let's go from there http://www.icknowledgecenter.com/forum/topics/ic-and-business-valua... Mary (running out just now but can also think about other resources--anyone else with ideas?)
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Permalink Reply by Geoff Turner on -
Welcome to the group Mike,
As Mary said, there are many sources of information that might be of use to you. For hat it is worth, a colleague and I recently published a small book entitled Strategic knowledge measurement: an integrative approach (ISBN: 978-3-8381-1284-8) that may be of some use to you.
Best wishes
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Permalink Reply by Len Ruggiero on -
Mike,
Without knowing what type of business you are in I would say that if your business consists of human capital assets more than anything else, it is difficult to place a value on those assets within the constraints of currently accepted accounting principals. However, there are several other areas of IC/IP that you should be aware of that may apply to your business.
For example, the IRS allows capitalization of brands, trademarks, management contracts, covenants not to compete, customer lists, technical drawings, and proprietary processes such as recipes used in food preparation, among other things. Since the IRS is the final arbiter of what can be capitalized and what can't, you should work with your accountant to verify what can be capitalized and thus depreciated.
Please see this IRS web site for more info:
http://www.irs.gov/publications/p535/ch08.html#en_US_publink1000158867
Also see IRS publication 535 for additional info on how to treat intangibles.
I would also say that while our current accounting systems are based on 19th Century technology, and while we all know intuitively and empirically that our companies are worth more than what the accounting system tells us, the challenge remains for the business owner to enhance the value of the firm within the constraints of the existing accounting system. In the final analysis, there are only two immediate advantages to recognizing IC/IP within the current accounting system. One is to increase depreciation and thus accounting cash flow or EBITDA, and second, is to monetize those identified and valued IC/IP assets by arranging asset based loans with financial institutions which will consider such assets as collateral.
Let me know if I can be of any more help.
Len Ruggiero
CEO, LaMarch Capital
len@lamarchcapital.com
Mike Healy said:Mary,
I am brand new to this group.
I am interested in the impact of intangibles on company valuation and what can be done to "beef up" the intangibles to make a company more atttractive to a buyer. I am particularly focused on human capital.
Any recommendations re: materials, checklists, tools spcifically focusing on this area.
Mike
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Permalink Reply by Len Ruggiero on
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Mike,
One additional comment: you could have your most valuable employees sign covenants not to compete which could be then be valued and depreciated.
Len Ruggiero
Mike Healy said:Mary,
I am brand new to this group.
I am interested in the impact of intangibles on company valuation and what can be done to "beef up" the intangibles to make a company more atttractive to a buyer. I am particularly focused on human capital.
Any recommendations re: materials, checklists, tools spcifically focusing on this area.
Mike
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Permalink Reply by Claus Nagel on -
Hi to all members o the group,
after all lot of discussions with M&A experts I came to the conclusion that there is not one value for intangible assets, there are many. Like there are many values for "tangible" assets in a company for example in an M&A process. The value of intangible assets depends on different aspects, for example the situation ( M&A process or a periodical valuation), it depends on the perspective ( buyer perspective or seller perspective), it depends on the framework of valuation (for example IFRS-Standards) and so on.
So in my opinion we should not try to find one value for intangible assets of a company. We should first describe the circumstances of the valuation.
Let me give some examples:
1.) In most M&A processes there is a long negotiation procedure between the buyer and the seller. During this process they discuss different prices of a wide range, all calculated with general accepted rules. In this case every structured information about intangible assets, like in an ic report, can help to find the final price. But is still a negotiation process not a calculation process.
2.) If you want to calculate the value of intangible assets according to regulations like these in the IFRS, you have to consider very strict and formal rules. One of these central rules says that the company must possess the intangible asset and it must be able to be sold on its own. According to the IFRS rules, you have to regard human capital as borrowed capital. The only capital you can regard as equity capital is the structural capital.
The consequence for a company is that it has to transform the human capital, the knowledge, into structures, as far as it is possible. This is also a suitable way under risk aspects. Human capital can leave the company very fast, that means high risk.
So I think that you have to choose the right valuation method according to the situation, but there will be no value for intangible assets which is more precise than the values of tangible assets and for tangible assets there is a wide range of values for one and the same asset.
I am looking forward to your comments.
Claus
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Thanks Claus- I agree with you that people often spend too much time thinking about valuation of intangibles.
Valuation isn't that helpful to a manager. A more important question is what does it cost to build, what does it cost to operate and what is the expected return from intangible asset capacity (we call this the knowledge factory).
In M&A, valuation is obviously very important. Here, there is a circular problem: valuation depends on cash flow analysis, cash flow is distorted by accounting for intangibles (actually lack of accounting for intangibles),
the intangibles information gap makes it difficult to analyze the repeatability and sustainability of cash flow.
Have you seen the data from E&Y on intangibles in M&A in 2007 in Acquisition Accounting: What's Next for You? It showed that 47% of the average deal was booked to "goodwill." Total intangibles were 70% on average. This is basically the value of unidentified intangibles investment. If no one understands what makes up this half of corporate value, then it will be impossible to understand the dynamic that you explain so clearly between human, relationship and structural capital.
For those of us in the IC community, it is amazing that the business world keeps stumbling forward without even trying to investigate the source of 70% of the value of the average merger...indeed, 70% of the value of the average company.
© 2012 Created by Mary Adams.
