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What is a Company Really Worth?
The Role of Internally-Produced Intangibles
Charles Hulten
University of Maryland and The Conference Board
Janet Hao
The Conference Board
*Presentation to the Comprehensive Firm Valuation Symposium
Rutgers Business School
September 14, 2010
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Name
Director, Associate Service
The Conference Board
Economic Research on Intangible Assets Has Found
That They Are Important Drivers of Economic Growth
and Corporate Wealth
 Macro intangibles
 Nakamura (1999, 2000)—intangible investment was $1 trillion a year.
 Corrado, Hulten, Sichel (2009)—intangible assets contributed to one
quarter of growth from 1995 to 2003.
 International comparison of sources of growth (Marrano, Haskel and Wallis,
2009, Fukao et. al. 2009, van Ark et al. 2009).
 Firm-level analysis
 Lev (2001)-called attention to intangible assets as a solution of price-book
gap.
 Hulten and Hao (2008)-reported results of intangibles on price-book gap.
 Hulten (2010)- study of Microsoft show company is virtually all intangibles,
both as inputs and outputs.
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One indication of how important intangibles are for US nonfarm business sector: More has been invested in intangible
assets than tangible assets in recent years (as % of output)
16%
14%
fixed capital investment
12%
10%
8%
6%
intangible investment
4%
2%
Source: Corrado and Hulten (2010).
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2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
1977
1974
1971
1968
1965
1962
1959
1956
1953
1950
1947
0%
Intangibles
 When we use the term ―intangibles‖, we mean the within-company
expenditures on product research and development, marketing and
brand equity, and organization development.
 Unlike intangibles reported on the company’s books, these internal
outlays are treated as costs on financial statements and not as
investments.
 CHS classification of intangibles:
Computerized
Information
Innovative
Property
Economic
Competencies
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•Software
•Databases
•R&D
•Mineral Exploration & Evaluation
•Copyright & licenses
•New products in financial industry
•Architectural & engineering designs
•Brand equity
•Firm-specific human capital
•Organizational structure
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Another Dimension of Intangible Assets: They can fill the
price-to-book gap. Here is the case of Johnson & Johnson
$ billion
250
200
150
Unexplained MV
100
Equity
50
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0
Source: Johnson & Johnson annual reports, various years.
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Our Method
Hulten and Hao (2008), What is a Company Really Worth? Intangible
Capital and the ―Market to Book Value‖ Puzzle. NBER wp14518.
Use Johnson & Johnson as an example.
Data source: Compustat (10-Ks from 1989 to 2008).
Estimate R&D Capital.
use R&D costs.
R&D capital in t =R&D capital in (t-1) + R&D investment in t –
R&D amortization in t.
Depreciate over 10 years.
Estimate organizational capital.
use about 30% of SG&A costs and varies across years. Estimate the
fraction using data from CHS (2005).
Org Capital in t =Org Capital in (t-1) + Org investment in t
– Org Capital amortization in t
Depreciate over 5 years.
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When Internally-developed Intangibles are Capitalized:
 Intangible assets account for 61% of total assets of Johnson &
Johnson in 2008.
- Internally developed intangible assets amount to 7 times
purchased intangible assets.
 After we capitalize intangible spending,
- earnings per share increase from $4.62 to $7.37.
- debt-to-equity ratio decreases from 1.00 to 0.31.
- return on equity ratio decreases from 0.30 to 0.15.
 Intangible assets contribute to the value of a firm substantially.
- the percentage of market value explained by equity increased
from 23% to 76%.
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$billions
Modified
Income
Statement
Johnson &
Johnson
2008
10-K
+R&D K
+ORG K
Conventional Revenues
63.7
63.7
63.7
Own production of R&D
0
11.1*
11.1*
Own prod. of Org. Capital
0
0
8.9*
Adjusted Value of Product
63.7
74.8
83.7
Conventional cost of sales
15.7
15.7
15.7
7.8
7.8
7.8
Current SG&A costs
21.3
21.3
21.3
Total current costs
44.7
44.7
44.7
Operating Surplus
19.0
30.1
39.0
2.8
2.8
2.8
Amort. of own-account R&D
0
5.4*
5.4*
Amort. of own-account org K
0
0
6.9*
Adjusted operating surplus
16.2
21.8
23.9
Net interest and other adjust.
0.8
0.8
0.8
16.9
22.6
24.6
4.0
4.0
4.0
After-tax income
12.9
18.6
20.6
Earning per share
4.62
6.63
7.37
Current R&D costs
Conventional depreciation
Before-tax income
Income tax paid
*Our estimates of
intangibles are in red.
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$billions
Modified
Balance
Sheet
Johnson &
Johnson
2008
10-K +R&D K
Current assets
34.4
34.4
34.4
Plant and equipment
14.4
14.4
14.4
Purchased intangibles
14.0
14.0
14.0
Goodwill
13.7
13.7
13.7
8.5
8.5
8.5
Total assets
84.9
84.9
84.9
Total liabilities
42.4
42.4
42.4
Equity
42.5
42.5
42.5
R&D capital
0
64.4*
64.4*
Organizational capital
0
0
31.8*
Assets adj. for own intang.
84.9
149.3
181.2
Equity adj. for own intang.
42.5
106.9
138.8
181.9
181.9
181.9
% Market value explained
23%
59%
76%
Debt-to-equity ratio
1.00
0.40
0.31
Other long-term assets
Market value of equities
*Our estimates of intangibles are in red.
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+ORG K
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Adding Intangibles to J&J Books Fills Price-to-Book Gap
$ billion
250
250
200
200
Unexplained MV
Unexplained MV
historic. cost adj.
Unexplained
Org.
capital MV
Org. capital
equity
R&D
capital
R&D capital
Equity
Equity
150
150
100
100
50
00
Source: Johnson & Johnson annual reports, various years.
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Decomposition of Market Value
of 633 R&D Intensive Firms
$ trillion
99
88
77
66
Unexplained MV
Unexplained MV
Historic. cost adj.
Org.
capital MV
Unexplained
Org. capital
R&D
capital
equity
R&D capital
equity
equity
55
44
33
22
11
00
Source: unpublished updates to Hulten & Hao (2008).
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Conclusion
 Internally-produced intangible assets are an important
source of company value.
 They are hard to measure precisely, and are not
capitalized on financial statements.
 Keynes: ―It is better to be imprecisely right than
precisely wrong.‖
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