CORPORATE VALUE CREATION, INTANGIBLES, AND VALUATION:
A DYNAMIC MODEL OF CORPORATE VALUE CREATION AND DISCLOSURE
by John Holland, Department of Accounting and Finance,
University of Glasgow, 65-71 Southpark Avenue, Glasgow
8LE, Ph 00 44 141 330 4136, Fax 00 44 141 330 4442,
E mail J.B.Holland@accfin.gla.ac.uk
G12
Acknowledgments to ICAS for funding this research:
The report begins in section 1 with an introduction to the field, a
discussion of policy issues, and a brief summary of the literature. In
section
2,
the
research questions and
research
methods
are
discussed.
The
literature revealed that there have
been
major
changes in the way companies create value in the new knowledge
intensive economy of the 21st Century. This has created problems
for
public
disclosure by companies. In addition,
the
research
literature
on disclosure has been dominated by positivistic
and
analytic model building. With the exception of the work by Lev
(1998), such approaches appeared ill suited to explaining the new
world
of
corporate
value creation
and
associated
disclosure
behaviour.
There has been some case study research and
the
development of grounded theory and this has proved to be more
promising
route
to
explaining the new
drivers
of
corporate
disclosure behaviour and outputs. Prior work by Marston (1996),
Barker
(1997), Holland (1998), Holland (2000),
revealed
the
significance of qualitative information and private meetings with
financial institutions as an important way of disclosing information
about companies sources of value. As a result, this research began
from the premise that understanding corporate disclosure behaviour
required
an
investigation of the new corporate
value
creation
processes and their impact on corporate disclosure behaviour.
Sections 3, 4 and 5 dealt with main grounded theory results of the
case interview and archival research. The report was based on case
interviews with
30 large UK FTSE 200 companies (24 in FTSE
100) during April to November 2000. Substantial archival data in
the form of web site disclosures, corporate reports, and media
comment, were also employed.
The companies interviewed were subject to continuous pressure
from the 'Market for information' , consisting of analysts, financial
media, and fund managers (FMs) in the City of London. These
FTSE 200 companies were subject to almost continuous pressures of
quarterly or half yearly reporting, of subsequent 1:1 meeting with
FM and analysts, and ad hoc telephone calls. They faced strong
demands to provide analysts, fund managers, and the financial
media, with new qualitative information to explain their
value
creation story, to report changes, and to discuss the stock price
implications of such information, all within Stock exchange rules on
'price sensitive' information.
As a result the firms faced three major issues,
1.
How can we understand and
articulate (to ourselves)
how
value was and is created in
the company - What is the nature of
our
value creation process ? and what is the role of knowledge
intensive intangibles and tangibles in this process ?
2. How can we value elements of the value creation process in
a
share
price
value equation ? How do our (value creating)
intangibles and tangibles effect our share price ?
3. How can we disclose information about the above processes and
sources of value? Subject to what constraints ?
The case interviews focused on the above areas. As result, the case
data had a bias towards issues of corporate financial
communications or private disclosure to analysts and fund managers
the City of London. It had a strong bias towards a capital market
and shareholder concepts of value as opposed to a wider stakeholder
concept of value. The internal managerial uses of knowledge of the
value creation process and the internal management of knowledge
intensive intangibles, were not addressed in this study. However,
the results may be of considerable interest to other major corporate
stakeholders such as middle managers, other employees, suppliers,
customers, and governments. Intellectual Capital (IC) is likely to be
seen as critical to the value creation process, irrespective of whether
shareholder, customer, employee or other stakeholder views of
'value' are employed to assess the process.
Section 3 outlined the broad nature of corporate value creation
processes, and the central role of intellectual capital or knowledge
intensive 'intangibles' in this process. These qualitative value
creation factors were discussed within the context of the prevailing
debate on intellectual capital and intangibles.
Intangible assets referred to knowledge intensive assets such as the
quality of brands, corporate reputation, a coherent strategy, the
quality of management, effective risk management, effective R&D,
and many others specific to companies or industries. These types of
asset were recognised as difficult to categorise or measure, but they
were also recognised as being increasingly important in corporate
share prices in the knowledge intensive economy. Tangible assets
referred to the visible, concrete assets and value creation processes
in companies.
A
specific
group of these intangible assets or qualitative value
creation factors, such as the quality of top management,
coherence
and credibility of strategy, structure and functioning of the
board, the quality of public and private disclosure
mechanisms,
and the quality of internal communication systems, were identified
as the primary drivers of the wider range of other internal human
and structural
capital elements to be found in value
creation
processes.
Notably,
top
management, the
coherence
of
their
strategy, and their ability to communicate these within the enterprise
were identified as primary drivers of middle management and other
employee human capital. These were used to fully exploit human
and operational structural capital during sourcing decisions and
processes,
transformation decisions and processes,
and
output
decisions and processes.
Section 4 provides the outline of a valuation equation that seeks to
connect the case companies concepts of the corporate value creation
process
with
their
understandings
of
stock
market
valuation processes.
There was no direct matching or alignment of the value creation
process model and a stock price valuation equation or model. The
share price
valuation model has been transposed on the corporate
value creation process. The share price valuation model reflected
how corporate management perceived the stock market valued the
company, and this did not necessarily fully incorporate how the
company
created
value. However, these two
processes
were
connected
by various linkages between value creation
process
variables
and stock price valuation variables. The
links
were
identified by the case companies during this field research and by
case FMs in prior (1997-2000) FM field research (Holland 2000). In
principle,
the valuation model employed by employees
or
by
customers, could also be connected to the value creation process in
the same way. The main difference being that the corporate value
creation processes identified in the cases were designed to increase
shareholder wealth as their primary purpose. This may be due to the
increase in use of value based management (VBM) systems such as
EVA, in the past decade. The common shareholder wealth creation
aim of the value creation and valuation processes made it possible to
identify links between them. It therefore provided the means to
discuss how knowledge intensive intangibles were driving share
prices. The latter explanations assumed market sentiment and other
disturbing factors were constant. At times, the dramatic changes in
the latter dominated company stock market valuations and
the
fundamentals based on a knowledge intensive value creation process
were thought to be made quite irrelevant from the case company
view. This was a major problem in corporate disclosure.
In section 5 of the report, a dynamic model of corporate disclosure
is outlined. This was made up disclosure content, choices, and
mechanisms , and constraints.
The increasing role of knowledge intensive intangibles in stock
prices has been identified in the literature as one major possible
reason for the book value and market value gap. This was an
important issue in the company cases, in that the perceived failure of
company financial statements to measure and disclose intangible
assets, was considered to be a failure in conventional corporate
disclosure mechanisms. The case managers lamented this fact, but
they recognised that the direction of change in current accounting
conventions meant they had little control over this issue. The failure
pointed up to the likely significance of intangibles in share prices.
Nevertheless, this failure provided an incentive for managers to find
alternative
disclosure
channels and to disclose
new
types
of
information consistent with the changes in corporate value creation
processes. Private disclosure of information on intangibles in the
value creation process, was the primary corporate response to this
failure of public disclosure. In practice, company managers were
strongly focussed on the stock price per se and the corporate, sector
and market determinants of stock price. The book value and market
value gap was not the main disclosure issue facing companies. The
central issue concerning corporate and sector determinants was,
what information on knowledge intensive intangibles was being
reflected in the share price, and what could the company do to
improve this information set? and hence get a 'correct' rating. Thus
the case companies focussed on areas where they had considerable
control.
In terms of disclosure content, the main information content lay in a
three major qualitative elements. These were, the telling of
a
coherent
and credible story of the knowledge
intensive
value
creation process, the disclosure of information concerning specific
changes in the core intangibles driving this process, and the placing
these changes in the context of the company story and competitive
position.
The 'story' was partially communicated through public disclosure
means such as the OFR or through company web sites. However,
these sources were fragmented and limited, especially with regard to
management qualities and coherence of the story. In contrast, in the
private meetings the story was conveyed through diagrams outlining
links in the value creation process, through dialogue, and interpreted
and developed through question and answer sessions. It was held
together
by a common 'story line' or connecting thread running
through the story. Thus the main aim here was to get over a larger,
coherent picture and to explain how it changed through time. In
addition, FMs and analysts were able to observe management in
'communication
action'
effectiveness and
this
provided
some
insights into their internal 'decision action' effectiveness.
In terms of specific changes in intangibles, these were 'measured' in
a variety of ways. Some intangibles such as effectiveness of R&D
could measured in absolute terms by the absolute R&D spend, and
by the number of observed innovations for this expenditure. Another
example, was the absolute discovery costs for an oil company, and
the number and size of observed new fields found by exploration.
These absolute numbers were ranked against competitors. However,
the bulk of intangibles and their contribution to value were difficult
to measure. In these case the broad category of intangible could be
identified, and its effectiveness could be ranked, implicitly
or
explicitly, on the basis of a FM or analysts subjective judgment,
relative to competitors or the sector. Information was generated here
by
observing
and
perceiving changes
in
relative
benchmark
indicators such as changes in the perceived ranking of management
relative to competitors, or the perceived market power of a brand
relative to competitors. The perceived changes here, derived from
private contact and observation, formed the basis of the disclosure.
Some disclosure here could be involuntary on the part of
the
company as well as being deliberate. Such changes were placed in
the
context of the larger value creation story, via the dialogue and
question and answer sessions, and this provided further disclosure
content.
This disclosure model also provided a comprehensive view of the
main
elements
and choices in a purposeful corporate disclosure
process. It generated important insights into the conditions under
which private and public corporate disclosure processes functioned
and it demonstrated how public and private corporate disclosure
interacted and changed with various circumstances. It also revealed
that the choices here were much wider and involved deliberate
corporate secrecy and non disclosure. It therefore revealed how
companies
exploited
these public, private and
non
disclosure
choices. Much of this choice behaviour was driven by managerial
opportunism, as well as the qualitative and difficult to measure
nature of knowledge intensive corporate value creation processes.
These choices were much constrained by external regulation, by
external
benchmarking by analysts and fund managers, and by
financial market forces.
This section therefore revealed forms
of
private FI
corporate
disclosure
behaviour
which
were somewhat
different
to
that
discussed in the literature on
public domain corporate disclosure.
They
provided a major expansion of the prior work
by
Marston
(1996),
Barker (1997), and Holland (1998) concerning
private
corporate disclosure.
Such disclosure behaviour followed on closely from the corporate
value creation processes, and top managements understanding of the
valuation equation implicit in stock market valuation processes.
Management therefore had to connect up their understanding of their
value creation processes to stock market value creations processes.
It was this understanding that was a primary driver of the corporate
disclosure process. There was no direct matching or alignment of
the
value creation process model and the corporate
disclosure
model. These were quite different managerial activities and hence
they had quite distinct structures. The value creation model was the
precursor of the disclosure model, in the sense that the former
provided the information raw material for the latter. The case
company perception of
stock price valuation equation or model
intermediated here between the value creation process and
the
disclosure process.
This was used to identify stock price information categories in the
value creation process, which were likely to be relevant to the
disclosure model. It was possible to bypass the valuation model and
to just release information on the value creation story and changes in
specific
intangibles to the stock market. Thus the
market
for
information could be left to deal with this. However, company
management recognised the need to have beneficial information
exchange relationships with analysts and fund managers. Thus by
adapting the information releases to match the known valuation
information needs of analysts and FMs the case managers expected
to improve the flow of information to a better informed stock
market.
Sections 3, 4, and 5 indicated that the model of the value creation
process did not reveal the value of a company's knowledge intensive
or IC assets. It revealed how the company created knowledge,
exploited knowledge, and used its knowledgeable individuals and
teams, as well as knowledge intensive
structures and processes to
create
flexible decisions options and innovative
products
and
services for the company. When a company articulated its story of
value creation, and this was combined with the valuation model,
then this provided the company with basis for making informed
decisions about disclosure to stock markets via public or private
disclosure. The stock market actually valued the company and its
intellectual capital assets. The company managers sought to ensure
that this market valuation fully reflected the complex story of value
creation in these modern knowledge intensive enterprises. They
were not seeking to value the company per se. They were seeking to
create a value creation process in the company and to communicate
this effectively to the stock market, so that the company
was
'correctly' valued.
In this paper we see that the value creation story was primarily told
or disclosed by the company. In a similar fashion, the company was
in the best position to identify the core intangibles and means to
rank them relative to competitors. However, the active dialogue on
(the appropriateness of) the story and on the relative measures was
conducted over many years. As a result, it could be argued that this
was
the
story
the City wished to
hear.
Thus
the
common
shareholder wealth maximisation aim of the case companies value
creation
story,
can be seen as
companies
internalising
FMs
performance needs expressed during this continuous dialogue. To
some extent the choice companies made about their value creation
processes, benchmark measures, and about their disclosure choices,
were determined by FMs, analysts, the financial media, and other
City influences.
Thus in this paper the value creation story, the
benchmark measures of intangibles, and the disclosure choices, are
seen as a two way 'contracts' determined between the company top
management and the City.
In section 6, the case results are discussed within the research
literature on the corporate disclosure. Given, the limitations of this
literature relative to changes in corporate value creation processes,
then the case research reported here suggests that future theoretical
modelling
and empirical research should extend
beyond
these
conventional approaches and consider the joint world of private and
public domain corporate disclosure and their effect on valuation.
Instead of modelling simple relationship between 'public disclosure'
as a dependent variable and
'independent'
variables, such
as
company characteristics, demand side characteristic, or national and
international factors,
the wider range of private and quasi public
disclosure behaviours should also be explored. Thus the 'black box'
of corporate value creation and its impact on corporate disclosure
has to be unravelled. Once general models exist here they can be
related
to
conventional disclosure research.
For
example
the
question could be asked how does company size, or listing status,
alter the grounded theory models of value creation and of public vs
private disclosure identified here ? How do national characteristics
such as
the
sophistication of stock
markets
or
markets
for
information, alter the grounded theory models of value creation and
of private
vs
public
disclosure identified
here
?
How
do
international developments as the integration of stock markets and
their regulations, or of accounting harmonisation, alter the grounded
theory models of value creation and of private vs public
disclosure
identified here ?
Finally, in section 7, the policy implications of the paper
are
discussed in terms of providing a much clearer target for future
policy
proposals
for changing
corporate
disclosure
practices,
especially in the area of accounting standards and stock exchanges
rules for company announcements.