Intangible Assets, Value Relevance,
and Accounting Anomalies
Wanncherng Wang
Professor of Accounting
Department of Business Administration
College of Management
National Sun Yat-Sen University
No. 70, Lienhai Rd., Kaohsiung 80424 Taiwan, R.O.C.
Email: wangw@mail.nsysu.edu.tw
Tel: +886-7-525-4511
1
Research Background
• Value drivers of firms—tangibles or intangibles
• Market valuation vs accounting valuation
– Market value and book value;
– Accounting and economic earnings have been an
unsolved issue in equity valuation.
• The valuation model--the relationship
between earnings, book value and share
prices.
2
Motivations
• Information contents of financial statements
– Does intangibles estimated from accounting
information predict future earnings?
• Low explanatory power of book value and
earnings
– Do intangibles thus estimated have explanatory
power for market value
– Do intangibles thus estimated predict future
returns?
3
Hypothesis Development
1. Incremental Explanatory Power for Stock Prices
and Future Earnings
– Recognition of intangibles is inconsistent across firms.
• Internally developed intangibles are not recognized as assets
whereas acquired intangibles, e.g., through a purchase
business combination, typically are recognized and amortized
against net income over the intangible’s estimated useful life.
– Second, changes in intangible values largely are
unaccounted for regardless of their magnitude.
– Third, expenditures that increase intangible values are
expensed in the period incurred rather than capitalized,
e.g., advertisement expenditures
4
Intangibles and Reported Earnings
• Simply put, all these accounting treatments
can result in firms that invest in intangible
development reporting depressed earnings
when their intangible values are increasing.
Consequently, it seems reasonable to expect
that a portion of firm value is missing from
book value. In other words, there is a missing
part in the link between book value and
market value—the intangible asset.
5
The Price-Book Relation
• H1: Intangible assets have incremental
explanatory power for the price-book relation.
6
Intangibles and Future Earnings
• The presence of intangible assets represents
future excess earnings ability. One can use book
value to predict future earnings in the sense
that earnings are created from investment.
– Therefore, future earnings based on recognized book
value will be underestimated when intangible assets
are missing from book value.
– Inclusion of intangible assets will increase the
predictive ability of book value for future earnings.
7
Predictive Ability for Future Earnings
• Therefore, the following hypothesis obtains.
• H2: Intangible assets have predictive ability for
future earnings, incremental to book value
and current earnings.
8
Stock Prices Incorporate Intangibles?
Operating cash flows and current accruals
1. Cash flows are realized in the current period,
while accruals represent future-period cash
flows
– Consequently, the market's valuation of accruals
should impound discounts for futurity and risk
(Dechow et al. 1996, 26)
9
Cash flows vs Accounting Earnings
2. Cash flows are more persistent than accruals.
– Future earnings levels are more highly associated
with current levels of operating cash flows than
with current levels of aggregate (current and
noncurrent) accruals.
3. 1+2 imply that a dollar of operating cash flows
should be valued more than a dollar of current
accruals, with a difference in magnitude
sufficient to compensate for differences in
futurity, risk and persistence.
10
Accruals Anomaly
• Investors seem to fixate on earnings and fail to
correctly distinguish between the different
levels of persistence of the accrual and cash
components of earnings. (Sloan, 1996)
• Sloan shows that a trading strategy based on
accounting accruals can earn abnormal
returns and he labels this phenomenon as
“the accrual anomaly”.
11
Accruals Anomaly
• The noisy measures hypothesis
– The lower persistence of accruals is often attributable to
the subjectivity of accrual measures (Richardson et al.
2004, 2005; Hirshleifer et al. 2005).
• Xie (2001) examines the market pricing of Jones (1991)
model estimated abnormal accruals to test whether
stock prices rationally reflect the one-year-ahead
earnings implications of these accruals.
• Cheng and Thomas (2006) extend this line of research
by employing multiple measures of abnormal accruals
to test their relation with both future annual returns
and future earnings announcement returns.
12
Do the stock market incorporate
information regarding future
capabilities contained in intangible
assets?
• Intangible assets sustain earnings and growth persistence
– one can expect a relationship between intangible assets and
earnings.
• intangible assets also introduce measurement errors into
book value and earnings,
– obscuring the predictability and raising the uncertainty of future
earnings.
13
Intangible Anomaly
• Given the conflicting influences of intangible
assets in market valuation, an interesting
question is whether and how the share
market values intangibles.
• If share prices are unable to fully reflect the
implications of intangibles for firms’ future
performance, one can expect a higher-thannormal returns for firms with higher
intangibles (CIV).
14
Intangible Anomaly
• In particular, current share prices will
underestimate the share values of firms with
high CIV, leading to future positive abnormal
returns. Therefore,
• H3: The share market fully reflects the
implications of intangibles regarding future
earnings.
15
Empirical Specifications
• Value Relevance of Intangible Assets
MV  0  1EQTY  2CIV  
where MV is the total market value of equity, CIV is total calculated
intangible value; Alternatively, the regression is also specified in a pershare basis.
PRC   0  1 BPS   2CIVPS  
where PRC is year-end price per share, BPS is book value per share,
and CIVPS is CIV per share.
16
Empirical Model
MVE / BVE   0 1 (1/BVE )   2 (NI/BVE )  3 (NEG_NI/ BVE )
  4 (RND/ BVE )  5 (ADVERT/ BVE )   6 (CAPEX/ BVE )
  7 (SALE_GROW /BVE )  8 (IC / BVE )  9 (IC / BVE )  ,
where MVE is the market value of equity measured 4 months following the fiscal
year-end, BVE is book value of equity, NI is net income before extraordinary,
NEG_NI is net income before extraordinary items if net income before
extraordinary items 0 otherwise, RND is R&D expenditures, ADVERT is
advertising expenditures, CAP_EX is capital expenditures, SALES_GR is annual
change in constant-dollar sales, is annual changes in estimated intangibles
value and CIV is the estimated year-end intangibles value.
17
;
The Predictive Ability of Intangible
Assets for Future Earnings
EPSt 1  0  1TACt  2OCFt  3 EPSt  4CIVPSt  
EPSt  2  0  1TACt  2OCFt  3 EPSt  4 EPSt 1  5CIVPSt  
where TAC is total accruals, OCF is cash flows from
operations, EPS is earnings per share from continuing
operations, CIVPS is CIV per share.
18
The Mishkin Tests—Rational Pricing of
Intangibles
, and
X t 1   0   1TACt   2OCFt   3 ICt   t 1
ARt 1  0  1 ( X t 1   0   1TACt   2OCFt   3CIVt )  t 1
where t is time index, TAC is accruals component, OCF is operating
cash flows, and CIV is intangibles.
19
Trading Returns to Zero Net
Investment Based on Intangible Assets
20
The empirical results
• Sample Selection and Descriptive Statistics
– The study sample includes all firms listed on TSE
and OTC (Taiwan) and covers the period of years
1989-2009. All financial and market data are from
Taiwan Economic Journal.
21
Descriptive Statistics
Table 1.
Descriptive Statistics
Panel A. Basic Statistics (N = 10,873)
Variable Mean
Std
5th Pctl
Dev
AR1
0.117
0.685
-0.510
AR
0.125
0.702
-0.518
PRC
29.324 36.987
4.110
BPS
15.764 7.216
6.750
CIVPS
4.278 19.249 -11.182
25th
Pctl
-0.188
-0.188
10.350
12.050
-3.632
50th
Pctl
0.000
0.000
19.100
14.500
1.338
75th
Pctl
0.253
0.259
35.350
17.950
7.933
95th
Pctl
1.113
1.188
83.500
28.030
26.829
Min
Max
-2.434
-2.434
0.330
0.050
-130.809
28.598
28.598
645.000
102.180
354.721
TAC
-0.020
0.119
-0.185
-0.076 -0.025
0.027
0.164
-0.866
0.953
OCF
0.066
0.116
-0.089
0.012
0.061
0.123
0.247
-1.034
0.891
BTM
0.961
0.893
0.222
0.446
0.735
1.190
2.381
0.011
25.000
EP
-0.023
0.437
-0.361
0.000
0.042
0.080
0.136
-16.042
14.400
AR is abnormal returns estimated following Fama and French (1993); AR1 = one-year-ahead AR; PRC
is price close per share; BPS = book value per share; BPS = book value per share; CIVPS = calculated
intangible value per share; TAC = total accounting accruals; OCF = operating cash flows; BTM = bookto-market; EP = earnings-to-price.
22
Descriptive Statistics
Panel B. Correlation Coefficients.
Pearson Correlation Coefficients (above diagonal) and Spearman Correlation Coefficients (below diagonal), N
= 10873
Prob > |r| under H0: Rho=0
AR1
AR
PRC
BPS
CIVPS
TAC
OCF
BTM
EP
AR1
1.00
-0.04
<.0001
-0.04
<.0001
-0.02
0.11
-0.02
0.10
-0.02
0.08
0.03
0.00
0.10
<.0001
-0.01
0.32
AR
-0.04
<.0001
1.00
0.29
<.0001
0.09
<.0001
-0.01
0.56
0.18
<.0001
0.06
<.0001
-0.24
<.0001
0.11
<.0001
PRC
0.00
0.67
0.37
<.0001
1.00
0.66
<.0001
0.46
<.0001
0.22
<.0001
0.29
<.0001
-0.39
<.0001
0.12
<.0001
BPS
0.02
0.01
0.17
<.0001
0.69
<.0001
1.00
0.47
<.0001
0.25
<.0001
0.25
<.0001
-0.25
<.0001
0.23
<.0001
CIVPS
0.04
<.0001
0.05
<.0001
0.45
<.0001
0.51
<.0001
1.00
0.10
<.0001
0.23
<.0001
-0.18
<.0001
0.10
<.0001
TAC
0.01
0.54
0.20
<.0001
0.31
<.0001
0.31
<.0001
0.18
<.0001
1.00
-0.59
<.0001
-0.23
<.0001
0.25
<.0001
OCF
0.10
<.0001
0.15
<.0001
0.32
<.0001
0.30
<.0001
0.32
<.0001
-0.50
<.0001
1.00
-0.13
<.0001
0.10
<.0001
BTM
0.01
0.27
-0.40
<.0001
-0.90
<.0001
-0.38
<.0001
-0.30
<.0001
-0.25
<.0001
-0.25
<.0001
1.00
-0.47
<.0001
EP
0.14
<.0001
0.26
<.0001
0.34
<.0001
0.51
<.0001
0.42
<.0001
0.32
<.0001
0.36
<.0001
-0.18
<.0001
1.00
23
Value Relevance of Intangible Assets
regarding Equity Valuation
Table 2. Regression Results.
(M1) MV     EQTY   CIV  
0
1
2
, where MV is total
market
value of equity,
CIV is total calculated intangible value;
(M2) ,
PRC   0  1 BPS   2CIVPS  
where PRC is year-end price per share, BPS is book value per share, and CIVPS is CIV per
share.
(M1)
Indep. Variable
INTERCEPT
EQTY
CIV
BPS
CIVPS
ADJ. R2
N
(M2)
Coef.
-2359228.00***
Coef.
-937928.00***
2.19***
1.76***
0.67***
0.76
10,999
0.81
Coef.
-23.34***
Coef.
-18.14***
3.36***
2.94***
0.33***
0.45
0.43
10,999
24
Table 3.
Equity value and intangibles
MVE / BVE  0 1 (1/BVE )   2 (NI/BVE )  3 (NEG_NI/ BVE )
  4 (RND/ BVE )  5 (ADVERT/ BVE )  6 (CAPEX/ BVE )
 7 (SALE_GROW /BVE )  8 (CIV / BVE )  9 ( CIV / BVE )   ,
here MVE is the market value of equity, BVE is the book value of equity, NI is net income before extraordinary
items, NEG_NI is negative earnings, RND is R&D expenditures, ADVERT is advertising expenses, CAPEX is
capital expenditures, measured by cash outflows for fixed assets, SALE_GROW is sale growth, is changes in
unrecognized intangibles assets, CIV is intangible assets as measure by calculated intangible value.
Variable
Parameter
Standard
t Value
Pr > |t|
Estimate
Error
INTERCEPT
0.95
0.02
43.41
<.0001
NI/BVE
3.10
0.12
25
<.0001
NEG_NI/BVE
-3.29
0.13
-25.65
<.0001
RND/BVE
5.99
0.21
28.76
<.0001
ADVERT/BVE
1.38
0.11
12.8
<.0001
CAPEX/BVE
-2.79
0.15
-18.49
<.0001
SALE_GROW/BE
0.00
0.00
0.9
0.3705
CIV/BVE
0.02
0.01
1.93
0.0537
CIV/BVE
0.03
0.01
3.89
<.0001
N
Adj. R2
9740
0.51
25
Does Estimated Intangible Assets
Predict Future Earnings
Table 4.
Earnings, accruals, operating cash flows and future earnings.
M1: EPSt 1  0  1TACt   2OCFt  ; 3 EPSt   4CIVPSt  
M2: EPSt  2  0  1TACt   2OCFt  3 EPSt   4 EPSt 1  5CIVPSt  
where TAC is total accruals, OCF is cash flows from operations, EPS is earnings per share from
continuing operations, CIVPS is CIV per share. (N = 8,443)
M1
M2
Coef.
Stddev
P-value
Coef.
Stddev
P-value
INTERCEPT
0.23
0.03
<.0001
0.21
0.03
<.0001
TAC
12.52
0.60
<.0001
1.05
0.60
0.08
OCF
13.81
0.61
<.0001
1.74
0.60
0.00
EPS
-0.15
0.13
0.2236
0.06
0.16
0.70
0.64
0.04
<.0001
0.02
0.00
<.0001
EPS(t+1)
CIVPS
0.07
0.01
<.0001
Adj R2
0.47
0.54
N
8,473
8,473
26
The Accrual Anomaly and the
Intangibles Anomaly
27
28
29
30