CORPORATE VALUE CREATION, INTANGIBLES, AND DISCLOSURE By - PDF document

CORPORATE VALUE CREATION, INTANGIBLES, AND DISCLOSURE By Professor John Holland, University of Glasgow, paper presented at the Institute of Accounting and Finance , Bocconi University (Milan), Italy, for the Centenary Celebration Conference, 25 th October 2002, "VALUES AND PRICES OF INTANGIBLE ASSETS: THE CONTROVERSIES THAT MATTER FOR COMPANIES AND MARKETS"

KNOWLEDGE INTENSIVE CHANGES IN REAL MARKETS IN TECHNOLOGY, CONSUMERS, PRODUCTS EFFECTING ROLE OF KNOWLEDGE INTENSIVE INTANGIBLES IN CORPORATE VALUE CREATION ALL CREATING NEW CORPORATE DISCLOSURE AGENDA PLUS MAJOR CHANGES IN INFORMATION AND FINANCIAL MARKETS EFFECTING FUND MANAGERS, ANALYSTS AND THEIR USE OF ABOVE CORPORATE VALUE CREATION INFORMATION ON INTANGIBLES CHANGE PROCESSING AND USE PROBLEMS CHANGE QUESTIONS ASKED OF COMPANIES HENCE CHANGE COMPANIES CONCEPT OF VALUE RELEVANT INFORMATION BOTH REAL MARKET AND FINANCIAL MARKETS CHANGES COMBINE TO ALTER CORPORATE DISCLOSURE GREATER FOCUS ON INTANGIBLES ENCOURAGE USE OF VALUE CREATION STORY AND BENCHMARKS EMPHASISE REPONSIVENESS AND ADAPTABILITY IN DISCLOSURE ALL OF ABOVE HAS MAJOR IMPLICATIONS FOR REGULATION OF DISCLOSURE IN THE INTERESTS OF STOCK PRICE FORMATION AND COMPANY VALUATION 2

Diagram 1 THE JOINTLY DETERMINED SUPPLY SIDE and DEMAND SIDE INFORMATION AGENDA INTERNAL COMPANY GOVERNANCE INFORMATION MARKET & STOCK +----------------------------+ +-------------------------- ---- & VALUE CREATION MECHANISMS¦ | MARKET INFORMATION DEMANDS | | | ¦ | � ==CONTINOUS FEEDBACK � = | ¦ | & LEARNING BY COMPANIES | | HIERARCHICAL VALUE | |----------------------------- ¦ ¦ | AT FM AND ANALYST LEVELS ¦ BOARD LEVEL CREATE¦ GREATER FOCUS NEW | MOSAICS & VALUATION MODELS, ¦ MECHANISMS AND NEW � ON � QS | ¦ PARTICIPANTS INFO¦ INTANGIBLES WHICH | SECTORS & PORTFOLIO CONTEXT ¦ ↓↓ AGENDA INFORMATION, DEFINE | ¦ INFLUENCE 4 ¦ � = & < � FM AND ANALYST VALUE ¦ VALUE DRIVERS ¦ ENCOURAGE USE CHANGE| CREATION PROCESS ¦ MANAGEMENT QUALITY � OF STORY & VALUE | ¦ EXECUTIVE PAY ¦ BENCHMARKS RELEVANCE | LARGER MARKET STORY LEVEL ¦ STRATEGY ¦ � = < � ¦ PERFORMANCE MEASURES ¦ EMPHASISE | PROBLEMS OF PROCESSING | | RESPONSIVENESS | INTANGIBLES INFORMATION, | | | CONFLICTS INTEREST, PSI. ¦ ↓↓ � |-------------------------- --- | | | ???? ¦ WHICH DRIVE CREATE | CHANGES IN MARKET STRUCTURE, | VALUE CREATION NEW ¦ | SOPHISTICATION, SENTIMENT, ¦ PROCESSES � | FASHION, & MARKET STORY, ¦ HORIZONTAL INFO¦ | INCREASED WEALTH MAXIMISATION ¦ & NETWORK AGENDA | EMPHASIS, INCREASE IN ¦ | | MARKET TIME PRESSURES +----------------------------+ +-------------------------- ---+ ↑↑↑ CHANGES IN REAL MARKETS, TECHNOLOGY, CONSUMERS,PRODICTS 3

INCREASING SIGNIFICANCE OF KNOWLEDGE INTENSIVE PROCESSES, ASSETS OR INTANGIBLES IN CREATING CORPORATE VALUE INCREASING USE OF TECHNOLOGY - INFORMATION TECHNOLOGY, BIOTECHNOLOGY NOW KNOWLEDGE CREATION, ARTICULATION, PROCESSING AND LEVERAGING, A CENTRAL SURVIVAL ACTIVITY FOR MNCS EFFECTIVE EXPLOITATION OF INTELLECTUAL CAPITAL CRITICAL FACTOR IN SUSTAINING COMPETITIVE ADVANTAGE INCREASED THE ABILITY OF INNOVATORS TO CHANGE THE RULES OF COMPETITION IN GLOBAL INDUSTRIES INCREASED THE CHANCE OF FAILURE IN THOSE COMPANIES FAILING TO INVEST IN KNOWLEDGE AND IT SKILLS. 1997-2000 RADICAL IDEAS ABOUT THE EMERGENCE OF A ‘NEW ECONOMY’. THE ISSUE OF INTELLECTUAL CAPITAL AND INTANGIBLES IS NOT A NEW ONE. WHAT IS NEW IS ITS GLOBAL IMPACT. THE CHANGES IN CORPORATE VALUE CREATION PROCESSES HAVE INCREASED THE INFORMATION ASYMMETRY BETWEEN USERS AND SUPPLIERS OF EQUITY RISK CAPITAL AS WELL AS CHANGING CHARACTER / CONTENT OF INFORMATION ASYMMETRY. HENCE PROBLEMS IN CORPORATE DISCLOSURE TO FINANCIAL MARKETS CONCERNING ACCOUNTING NUMBERS, FINANCIAL STATEMENT TEXT DISCLOSURE, PUBLIC ANNOUNCEMENTS TO THE STOCK EXCHANGE AND INCREASED THE SIGNIFICANCE OF PRIVATE DISCLOSURE OF INFORMATION ESPECIALLY THE PRIVATE DIALOGUE BETWEEN COMPANIES AND SUPPLIERS OF CAPITAL ABOUT THE ROLE OF INTANGIBLES IN VALUE CREATION. 4

THREE VALUE CREATION PROCESSES WITHIN CASE COMPANIES WERE MUCH EFFECTED BY THESE CHANGES THIS HAS CHANGED THE DISCLOSURE AGENDA TOWARDS INFORMATION ON THE FOLLOWING INTANGIBLES 1. HIERARCHICAL - GENERATED THE PURPOSE, IMPETUS, OR MOMENTUM OF VALUE CREATION. INTANGIBLES SUCH AS THE QUALITY OF DIRECTORS, AND OF TOP MANAGEMENT COHERENCE OF STRATEGY, EFFECTIVENESS OF PAY SCHEMES. EFFECTIVENESS OF PERFORMANCE MEASURMENT SYSTEMS ALIGNEMENT OF THESE – WITH EACH OTHER & SWM . 2. ‘HORIZONTAL’ OR PROCESS MODEL OF INPUT � PROCESS � OUTPUT . INPUT INTANGIBLES SUCH AS EFFECTIVE SUPPLIER RELATIONS, SUPPLY CHAIN MANAGEMENT SKILLS, THE QUALITY OF STAFF TRAINING, RETENTION AND RECRUITMENT, SKILLS IN IDENTIFYING OR BUYING INFORMATION ON NEW CONSUMER NEEDS, SKILLS IN INTERNALLY DISCOVERING, BUYING IN, OR COPYING NEW SCIENTIFIC AND TECHNOLOGY DEVELOPMENTS. TRANSFORMATION INTANGIBLES EFFECTIVENESS OF R&D SYSTEMS, AND OF INNOVATION FOR NEW PRODUCTS, OF TESTING PRODUCTS OF PATENTING, OUTPUT INTANGIBLES SUCH AS BRAND POWER, EFFECTIVENESS OF BRAND MANAGEMENT, SKILLS IN BUYING IN BRANDS AND BRAND MANAGEMENT SKILLS, O BROADER MARKETING AND PROMOTION SKILLS, EFFECTIVENESS OF MANAGING PATENTS AND THEIR EARNINGS, QUALITY OF DISTRIBUTION SYSTEMS, QUALITY OF CUSTOMER DISTRIBUTOR RELATIONSHIPS, 5

3. A NETWORK VALUE CREATION PROCESS INVOLVING SHARING OF BOTH TANGIBLE AND INTANGIBLE VALUE DRIVERS VIA SUPPLY, PRODUCTION Diagram 2 THE INTERNAL CORPORATE GOVERNANCE (CG) & VALUE CREATION (VC) CHAIN DETERMINING THE NEW SUPPLY SIDE INFORMATION AND DISCLOSURE AGENDA COMPANY INTERNAL CG & VC CHAIN +----------------------------+ ¦ ¦ ¦ HIERARCHICAL VC ¦ KNOWLEDGE ¦ +------------+ ¦ INTENSIVE ¦ ¦BOARD CH,NEDs ¦ CHANGING DISCLOSURE AGENDA ABOUT BOARD, ¦ ¦& committees¦ ¦ CHAIRMAN (CH), NON EXECS (NEDs), === � ¦ ¦ ¦ ¦ CHIEF EXECUTIVE (CE), FINANCE DIRECTOR (FD), ¦ ¦ WHO ¦ ¦ AND ABOUT DISCLOSURE QUALITY, CHANGES IN ¦ ¦¦ GOVERN ¦¦ ¦ OPPORTUNISM & OTHER TOP LEVEL ¦ ¦¦ ¦¦ ==== � INTANGIBLES ¦ ¦¦ CE ¦¦ ¦ TECHNOLOGY ¦ ¦¦ FD, EDs ¦¦ ¦ ¦ +¦----------¦+ ¦ COMPETITION ¦ ¦ ¦ ALL INFLUENCE === � CHANGING DISCLOSURE CONSUMERS ¦ 4 VALUE DRIVERS ¦ AGENDA ABOUT VALUE DRIVER ¦ ¦ INTANGIBLES ¦ TM-----STRATEGY ¦ ALL DRIVE ¦ QUALITY ¦ ¦ AND HOW THEY ARE ALIGNED WITH ¦ ¦ ¦ == � EACH OTHER AND WEALTH CHANGES IN ¦ PAY ----- VBM ¦ MAXIMISATION AIMS ¦ SCHEMES EVA ¦ COMPANY ¦ ¦ ¦ WHICH DRIVE HORIZONTAL ¦ VALUE CREATION ¦ || & NETWORK VALUE CREATION ¦ \/ ¦ & INFORMATION ¦ +------------+ ¦ CHANGING DISLCOSURE AGENDA ¦ ¦COMPANY ¦ ¦ ABOUT STAFF TRAINING, R&D, MARKETING, AGENDA ¦ ¦VALUE ===> ===== � BRANDS, SUPPLY CHAIN MANAGEMENT & OTHER VC ¦ ¦CREATION ¦ WHICH ¦ INTANGIBLES & THEIR INFERRED IMPACT ON ¦ ¦PROCESS & ¦ CREATE ¦ FINANCIAL PERFORMANCE == � ¦ ¦ROLE OF ¦ ¦ ¦ ¦INTELLECTUAL¦ ¦ ¦ ¦CAPITAL ASSETS AND DISCLOSURE/OBSERVATION OF ¦ ¦ AND ======== � OTHER INTANGIBLES SUCH AS ¦ ¦INTANGIBLES ¦ STRATEGIC & COMPETITIVE POSITION ¦ +------------+ ¦ & TRACK RECORD +----------------------------+ 6

THE STORY THE ‘STORY’ OR BUSINESS MODEL IS PRIMARY VEHICLE FOR PRIVATE DISCLOSURE STORY CONTENT = ORAL OR WRITTEN NARRATIVE ABOUT THREE VALUE CREATION PROCESSES CONNECTS KEY INTANGIBLES IN THESE PROCESSES AND THEIR IMPACT ON PERFORMANCE BUT NOT POSSIBLE TO DISCLOSE FULL TECHNICAL DETAILS OF THE ABOVE 3 VC PROCESSES IN A STORY, NOT NORMALLY TRANSMITTED DUE TO TIME, IGNORANCE, TOO COMPLEX, TOO BORING - HENCE STORY IS 'FRAGILE', SKETCHY BUT CAN REVEAL LESS SPECIFIC, SUB STORIES ABOUT R&D SUCCESS, PRODUCT INNOVATION, EXCELLENT BRAND MANAGEMENT, ETC STORY NARRATIVE CONNECTS INVISIBLE ELEMENTS VIA STORY OF INVISIBLES ==> VISIBLES ===> PERFORMANCE HOW TACIT VC ==> EXPLICIT VC ==> EFFECTS PROFITS / PRICE IN 3 VALUE CREATION PROCESSES HOW R&D = � INNOVATION = � PATENTS = � PRODUCTS � SALES TACIT KNOWLEDGE ABOUT HC, INDIVIDUALS, TEAMS, EVENTS 7