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To cite this document:
Ousama Abdulrahman Anam Abdul Hamid Fatima Abdul Rashid Hafiz Majdi, (2011),"Effects of intellectual
capital information disclosed in annual reports on market capitalization", Journal of Human Resource
Costing & Accounting, Vol. 15 Iss 2 pp. 85 - 101
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Effects of IC
information
85
1. Introduction
In the knowledge-based economy or knowledge economy (KE), the main economic
resources are no longer physical capital, natural resources and labor, but knowledge
itself (Drucker, 1992). Thus, a KE is an economy in which the generation, application and
exploitation of knowledge play an important role as the driving forces of economic
The authors gratefully acknowledge the many constructive and insightful comments received
from the reviewers.
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86
growth (Leadbeater, 1999; Goh, 2005). Knowledge Economy companies tend to create
value based on intangible capital and resources rather than tangible ones (Abeysekera,
2006; Whiting and Miller, 2008). Consequently, this has resulted in hidden capital, which
is the difference between the market and book values of the companies. This hidden
capital is recognized and valued by the market (Al-Ali, 2003; Ordonez de Pablos, 2003).
Broadly speaking, this hidden capital can be called intellectual capital (IC) (Stewart,
2000; Brennan, 2001). Therefore, there is increasing recognition of the role of IC in
driving the market value of the company (Chen et al., 2005).
IC can be defined from the perspective of wealth creation as intangible resources and
assets that an organization can use to create value by converting it into new processes,
products, and services (Al-Ali, 2003, p. 5). Similarly, Stewart (2000, p. xi) defines IC as
intellectual material knowledge, information, intellectual property, experience that
can be put to use to create wealth. IC is usually classified into three main categories,
based on one of the most popular classifications by Sveiby (1997), who classifies IC as
internal structure, external structure and employee competence. This classification of IC
by Sveiby (1997), is often referred to and adopted by the IC literature (April et al., 2003;
Abeysekera and Guthrie, 2005; Wong and Gardner, 2005; Whiting and Miller, 2008),
with slight modification of the terminology of the categories into internal capital (INC),
external capital (EXC) and human capital (HUC). INC refers to the IC inside the company
which consists of innovations, technological infrastructure, internally generated
intangible assets (e.g. patents, brand names and trademarks), quality, processes and
management philosophy (Sanchez et al., 2000; Guthrie and Petty, 2000; Bontis, 2003;
Seetharaman et al., 2004). On the other hand, EXC refers to the IC that exists outside of
the company, which includes business partnering and alliances, business combination,
information about customers (e.g. information about the customers number or market
share), customers satisfaction, suppliers (e.g. information about suppliers), distribution
channels, marketing, market value and share price, and shareholders (Sanchez et al.,
2000; Brennan, 2001; Bontis, 2003; Seetharaman et al., 2004; Olsson, 2004). Finally, HUC
refers to the human resources of the company which include employees education,
skills, training, values and experience (Sanchez et al., 2000; Guthrie and Petty, 2000;
Bontis, 2003; Seetharaman et al., 2004).
There are some prior empirical studies in developed economies that examine the
impact of the extent of disclosure in general (e.g. voluntary, mandatory, both) on the
market value of the companies (Botosan, 1997; Lang and Lundholm, 2000), and which
report a significant relationship. On the other hand, in emerging economies some
empirical studies (Ragab and Omran, 2006) show the effect of general disclosure on
market valuation. This indicates that when the information is useful, it is valued by the
market (Hassan et al., 2011). Looking at the disclosure of IC, there are a limited number of
studies that specifically examine the relationship between IC disclosure and market
value (as will be discussed in the literature review section). Nevertheless, these studies
found that there is a positive significant relationship between the two. However,
in Malaysia, as an emerging economy, so far, there are no studies that examine the effect
of IC disclosure in the annual reports of listed companies on their market value.
Therefore, this research is motivated by the fact that such a study is warranted since IC
(i.e. hidden value) may or may not be captured by the market in emerging economies like
Malaysia, which may be subjected to market imperfections.
Based on the need to discover whether a relationship exists, the main objective of
this paper is to examine the effects of IC information disclosed in the annual reports of
listed companies on Bursa Malaysia (BM)[1] on their market capitalization (MCAP)[2].
The paper makes several contributions. First, it contributes towards the IC literature in
Malaysia, especially on the issue of the effects of IC information on the market value of
the company. Second, since it was found that IC disclosure does affect MCAP, the
paper contributes towards practice by highlighting the importance of IC disclosure to
the Malaysian-listed companies as this affects their MCAP. Thus, the findings should
motivate these companies to disclose more IC information. Third, the paper contributes
to the policy making by providing empirical evidence on the effects of IC disclosure on
listed companies MCAP to the regulatory bodies (e.g. Malaysian Accounting Standard
Board (MASB); BM). Thus, these regulatory bodies may enhance the voluntary
disclosure of IC information in the annual reports of listed companies by developing
disclosure guidelines.
The paper is structured as follows. Section 2 reviews literature on the relationship
between IC information and firm value. This is followed by the theoretical framework
and hypotheses development section. Section 4 discusses the research method.
Section 5 provides the results and their discussions. Section 6 concludes the paper.
2. Literature review
Very few studies have been conducted to examine the effects of IC disclosure on market
value or MCAP; among them are: Abdolmohammadi (2005) in the USA, Orens et al.
(2009) in continental European countries and Abeysekera (2011) in Sri Lanka. These
studies found that there is a positive significant relationship between IC disclosure and
MCAP. The argument underlining such a relationship is that when there are IC related
activities, it would be a significant part of a companys values. Thus, these values
contribute to the MCAP of the company. As a result, a company would expect to report
these values with more IC disclosure to explain their effects on MCAP[3]. Supporting
empirical evidence can be found, for example, in Abdolmohammadi (2005). He found
that the IC disclosure in the annual reports of US companies had a highly significant
( p , 0.01) relationship with their market values. This finding indicates that there are
greater benefits than costs for companies to disclose more IC information voluntarily
(Abdolmohammadi, 2005). Similar to Abdolmohammadi (2005), Orens et al. (2009)
focused on the impact of internet-IC disclosure (i.e. web-based) on the company value
for four continental European countries (i.e. Belgium, France, Germany and
The Netherlands). The findings of their study supported those of Abdolmohammadi
(2005), as they found that there was a positive significant effect on the extent of
internet-IC disclosure on company value. Further support for the significant
relationship between IC disclosure and MCAP can be found in Citron et al. (2005).
They found that there was a positive relationship between IC disclosure in the annual
reports and the market value of UK companies (although this relationship was
significant only for EXC and INC, but not for HUC).
On the other hand, Abeysekera (2011) reports a study conducted in a developing
country, Sri Lanka, to examine the influence of IC disclosure (i.e. narrative, visual and
numerical) on market value of companies during two political settings (i.e. civil war and
temporary truce). He found that IC disclosure (i.e. narrative disclosure) had a positive
significant effect on the MCAP during the period of temporary truce, but not during
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the civil-war period. These findings are interesting as the results, during peace,
are consistent with the findings of the studies in the developed countries. Overall, it can
be seen that the findings of the positive significant relationship (i.e. between IC
disclosure and market value) are consistent with the findings of the general disclosure
literature (e.g. voluntary, mandatory and both) which found that the extent of disclosure
in the annual reports positively affect the MCAP.
Within the extant of Malaysian literature, there are a number of studies that examined
the issue of IC from different perspectives (e.g. measurement, performance, disclosure
and usefulness), such as Bontis et al. (2000), Goh and Lim (2004), Seetharaman et al. (2004),
Saudah et al. (2004), Wan Fadzilah et al. (2004), Faridah (2004), Goh (2005), Amilia (2006),
Abdul Latif and Fauziah (2007), Huang et al. (2007), Shaniz Khan and Daing Nasir (2007),
Zuliana (2007), Norman et al. (2009), Amrizah and Rashidah (2009), Huang et al. (2010) and
Ousama et al. (2011). However, none of these studies extended IC disclosure in the annual
reports to investigate its affects on MCAP. Thus, the current paper can be considered as
the first to test the relationship between IC disclosure and market value in Malaysia.
Consequently, it is hoped that a study in this area would produce findings that are
beneficial, while simultaneously filling the gap in the Malaysian IC literature.
3. Theoretical framework and hypotheses
Previous studies have tried to identify a link between disclosure in general (i.e. voluntary,
mandatory and both) and MCAP (Healy and Palepu, 1993; Welker, 1995; Botosan, 1997;
Lang and Lundholm, 2000). The findings of these studies reveal that increasing the
extent of disclosure results in decreasing the misevaluation of a companys share price,
hence increasing its MCAP. However, with regards to IC disclosure, as mentioned
earlier, there are few studies, which examine the relationship between IC information
disclosure by companies and their MCAP. The findings of these studies also indicate
that there is a significant positive relationship between IC disclosure and MCAP. Thus,
these findings are consistent with findings on the voluntary disclosure studies which
found the extent of voluntary disclosure in the annual reports and MCAP to be positively
associated (Abdolmohammadi, 2005).
Resource-based theory can be used to explain the relationship between the IC
disclosure in the annual reports and the MCAP. It is known that IC is one component of
the company capital and resources, and it contributes to the wealth creation of the
company. Therefore, when companies disclose more IC information in their annual
reports, it enables the stakeholders to understand the wealth creation process. As a
result, such disclosure will decrease the misevaluation of the companys share prices,
and increase MCAP. Furthermore, the signalling theory can also be applied to explain
this relationship. The management of a company that has good value (as a result of the
value creation process of its capital and resources which include IC) will try to signal this
fact by disclosing more IC information in the annual reports to its stakeholders. Thus,
this information might be reflected in the market value (MCAP) of the company. On the
other hand, if there is no effect of such information on the market value of the company,
there would be no reason to signal. In addition, disclosing information about IC might
enable the user to better determine the companys future value which might result in
increasing the companys share price.
Based on the above discussion, the following theoretical framework is developed
(Figure 1). The framework depicts that IC information (i.e. independent variable IV)
will affect the MCAP (i.e. dependent variable DV). In addition, the framework shows
that book value, net profit, firm size and leverage (i.e. control variables CVs) will also
affect the MCAP.
Therefore, based on the theoretical framework, it can be hypothesized that IC
disclosure in the annual reports would have a positive relationship on MCAP. Thus,
the following hypotheses were formulated, in the alternate form:
H1. The disclosure of IC information by Malaysian-listed companies in the year
2002 has a positive significant effect on their MCAP.
Effects of IC
information
89
Book value
Net profit
Firm size
Leverage
(CVs)
Market
capitalization
(DV)
Figure 1.
Theoretical framework
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90
Table I.
Sample size based
on companies and
annual reports
Consumer products
Industrial products
Construction
Trading and services
Properties
Plantation
Others
Total
Population
58
105
35
106
83
38
16
456
11
21
7
21
17
8
6
91
22
42
14
42
34
16
12
186
Independent and control variables. In addition to the independent variable (EICD), there
are four control variables (i.e. book value, net profit, firm size and leverage) included in
the regression model. The inclusion of these control variables was due to their
plausible effect on MCAP as found by prior studies (Abdolmohammadi, 2005;
Citron et al., 2005; Orens et al., 2009; Abeysekera, 2011). The measurement of the
independent and control variables are specified as follows:
(1) EICD is measured based on a disclosure index that was developed by adopting
Sanchez et al.s (2000) work with significant modifications based on prior IC
disclosure literature (Sveiby, 1997; Stewart, 2000; Guthrie and Petty, 2000;
Bontis et al., 2000; Brennan, 2001; Williams, 2001; Bontis, 2003; Ordonez de Pablos,
2003; Olsson, 2004; Goh and Lim, 2004; Seetharaman et al., 2004; Abeysekera and
Guthrie, 2005; Abdolmohammadi, 2005; White et al., 2007). Finally, the disclosure
index consists of 101 items that are within the three IC categories (i.e. 35 items for
INC, 35 items for EXC and 36 items for HUC)[5]. A dichotomous scoring system
was used, where 1 is assigned when an item in the disclosure index is disclosed
in the annual report and 0 otherwise, as measured in prior studies
(Abdolmohammadi, 2005; White et al., 2007; Omar, 2008).
(2) Book value (BVALUE) is measured by the difference between total assets and
total liabilities at the end of the accounting year, as measured in prior studies
(e.g. Ibrahim et al., 2004; Abdolmohammadi, 2005).
(3) Net profit (NETPROFT) is measured by the net profit of the company at the end
of a reporting year as measured in prior studies (Citron et al., 2005; Zuliana,
2007; Orens et al., 2009).
(4) Firm size (SIZE) is measured by the total assets of a company at the end of a
reporting year, as measured by prior studies (Beaulieu et al., 2002; Bozzolan et al.,
2003).
(5) Leverage (LEVERAGE) is measured as a ratio of total liabilities to shareholders
equity, as measured in prior studies (Williams, 2001; Zuliana, 2007; Omar, 2008).
4.4 Regression model
To examine whether the market perceives IC disclosure information as an important
variable in the determination of the companys market value, a multiple ordinary least
square regression model based on the transformation of the variables to normal scores
was adopted[6]. The regression model is adopted from prior studies with modification[7]
(Abdolmohammadi, 2005; Orens et al., 2009; Abeysekera, 2011). The framework of this
model was originally developed by Ohlson (1995). The model includes the dependent
variable (MCAP), independent variable (EICD) and control variables (BVALUE,
NETPROFT, SIZE and LEVERAGE) and specified as follows:
MCAP jt a b1 EICDjt b2 BVALUE jt b3 NETPROFT jt b4 SIZE jt
b5 LEVERAGE jt ejt
where:
MCAPjt
EICDjt
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BVALUEjt
SIZEjt
92
ejt
error;
bI
Table II.
Descriptive statistics
of variables for the
year 2002
Table III.
Descriptive statistics
of variables for the
year 2006
Mean
Median
SD
Mean
Median
SD
MCAP
(million)
EICD
BVALUE
(million)
NETPROFT
(million)
SIZE
(million)
LEVERAGE
1,053
202
3,213
0.223
0.207
0.055
784
254
1,902
43
16
181
1,680
582
4,122
1.443
0.634
2.112
MCAP
(million)
EICD
BVALUE
(million)
NETPROFT
(million)
SIZE
(million)
LEVERAGE
1,806
224
4,950
0.238
0.218
0.066
996
334
2,432
90
19
301
2,045
650
5,021
1.330
0.643
1.857
Effects of IC
information
93
1.000
EICD
0.593 *
0.000
1.000
BVALUE
NETPROFT
0.824 *
0.000
0.551 *
0.000
1.000
0.703 *
0.000
0.473 *
0.000
0.578 *
0.000
1.000
SIZE
0.680 *
0.000
0.489 *
0.000
0.876 *
0.000
0.447 *
0.000
1.000
LEVERAGE
20.109
0.306
20.019
0.859
20.080
0.450
20.170
0.107
0.317 *
0.002
1.000
Notes: Significant at: *0.01 level (2-tailed); the values in bold font are the Pearson/Spearman
correlation coefficients; the values in italic font are the significance levels
Table IV.
Correlation analysis
results of the variables
for the year 2002
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MCAP
MCAP
EICD
94
1.000
EICD
BVALUE
NETPROFT
0.661 * * *
0.000
1.000
0.865 * * *
0.000
0.581 * * *
0.000
1.000
0.687 * * *
0.000
0.450 * * *
0.000
0.613 * * *
0.000
1.000
BVALUE
NETPROFT
SIZE
Table V.
Correlation analysis
results of the variables
for the year 2006
0.746 * * *
0.000
0.560 * * *
0.000
0.833 * * *
0.000
0.440 * * *
0.000
1.000
20.153
0.148
0.109
0.304
20.148
0.162
20.234 * *
0.025
0.204 *
0.053
1.000
Notes: Significance at: * * *0.01, * *0.05 and *0.10 levels (two-tailed); the values in bold font are the
Pearson/Spearman correlation coefficients; the values in italic font are the significance levels
Constant
EICD
BVALUE
NETPROFT
SIZE
LEVERAGE
Coefficient
SE
t-statistic
Sig. t
2 0.000
0.131
0.817
0.304
2 0.266
0.095
0.049
0.064
0.178
0.066
0.180
0.087
0.000
2.057
4.584
4.608
2 1.480
1.092
1.000
0.043 *
0.000 * *
0.000 * *
0.142
0.278
Notes: Significance at: * * *0.01 and * *0.05 levels; R 2 0.773; Adj. R 2 0.760; F-value 58.041;
Sig. F 0.000; D-W 2.158
Variable
Table VII.
Regression results of the
effects of ICD on MCAP
for the year 2006
LEVERAGE
LEVERAGE
Variable
Table VI.
Regression results of the
effects of ICD on MCAP
for the year 2002
SIZE
Constant
EICD
BVALUE
NETPROFT
SIZE
LEVERAGE
Coefficient
SE
t-statistic
Sig. t
20.000
0.215
0.439
0.217
0.185
20.098
0.044
0.059
0.112
0.060
0.103
0.059
20.001
3.655
3.909
3.615
1.798
21.668
0.999
0.000 * * *
0.000 * * *
0.001 * * *
0.076 *
0.099 *
Notes: Significance at: * * *0.01 and *0.10 levels; R 2 0.824; Adj. R 2 0.813; F-value 79.506;
Sig. F 0.000; D-W 1.988
The results show that EICD was positively significant ( p , 0.05) even with BVALUE
and NETPROFT in the regression model. The results reveal that the EICD can be
considered as a predictor of MCAP. This finding is consistent with prior IC disclosure
studies (Abdolmohammadi, 2005; Orens et al., 2009; Abeysekera, 2011), which found it to
be statistically significant. The significant positive coefficient of EICD (i.e. overall)
indicates that the more disclosure of information about IC, the higher MCAP would be.
Several possible reasons can explain the significance of the EICD. First, as there
Effects of IC
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and 2006, respectively. In addition, the results show that all control variables
(i.e. NETPROFT, SIZE and LEVERAGE) are statistically significant in the two years
(i.e. 2002 and 2006).
5.5 Sensitivity analysis
A sensitivity analysis was conducted using a dummy variable for year (i.e. 0 for year
2002 and 1 for year 2006); the results are shown in Table X. The results support the
results in Tables IV and V that EICD significantly impact the MCAP. In addition, the
results supported the significant results of BVALUE and NETPROFT for both years.
However, SIZE and LEVERAGE were not significant, perhaps again due to the
stronger affect of BVALUE on MCAP.
Variable
Table VIII.
Regression results with
omitting BVALUE
for the year 2002
Constant
EICD
NETPROFT
SIZE
LEVERAGE
Constant
EICD
NETPROFT
SIZE
LEVERAGE
t-statistic
Sig. t
20.000
0.175
0.365
0.494
22.200
0.055
0.070
0.072
0.077
0.065
0.000
2.509
5.090
6.440
23.055
1.000
0.014 *
0.000 *
0.000 *
0.003 *
Coefficient
SE
t-statistic
Sig. t
20.000
0.266
0.289
0.515
20.219
0.047
0.062
0.062
0.064
0.054
20.002
4.288
4.702
8.053
24.028
0.999
0.000 *
0.000 *
0.000 *
0.000 *
Notes: Significant at: *0.01 level; R 2 0.792; Adj. R 2 0.783; F-value 81.950; Sig. F 0.000;
D-W 1.981
Variable
Table X.
Regression results of the
sensitivity analysis
SE
Notes: Significant at: *0.01 level; R 2 0.717; Adj. R 2 0.704; F-value 54.594; Sig. F 0.000;
D-W 2.085
Variable
Table IX.
Regression results with
omitting BVALUE
for the year 2006
Coefficient
Constant
EICD
BVALUE
NETPROFT
SIZE
LEVERAGE
YEAR
Coefficient
SE
t-statistic
Sig. t
2 0.000
0.174
0.539
0.261
0.055
2 0.039
2 0.000
0.047
0.043
0.096
0.045
0.092
0.049
0.066
0.000
4.007
5.603
5.826
0.597
2 0.791
0.000
1.000
0.043 *
0.000 * *
0.000 * *
0.551
0.430
1.000
Notes: Significance at: *0.05 and * *0.01 levels; YEAR 0 for the year 2002 and 1 for the year 2006;
R 2 0.790; Adj. R 2 0.783; F-value 110.000; Sig. F 0.000; D-W 2.074
Effects of IC
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7. The difference in the current model compared to prior models is in terms of using the
normalized variables.
8. All regression analysis assumptions were tested and results show that they were met.
9. The paper has performed regressions based on the categories of IC (i.e. INC, EXC and HUC)
for both years. The results are consistent with the main findings.
98
10. BVALUE and SIZE seem to be even more highly correlated than BVALUE and NETPROFT,
thus BVALUE is excluded from the additional analysis.
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Corresponding author
Ousama Abdulrahman Anam can be contacted at: osamaanam@gmail.com
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