Intellectual Capital from the Analyst Point of View

This paper by the European Federation of Financial Analysts Society (EFFAS) is entitled, Principles for Effective Communication of Intellectual Capital, opens up with the statement:

High time for the financial community to tackle intangibles:

In developed economies today the most important factors associated with corporate competitiveness and growth are invisible. These intangible assets – collectively called intellectual capital – range from staff and management skills, software, R&D, brands and patents all the way to strategies, processes, and relationships with suppliers and customers. Yet despite its paramount importance, intellectual capital is still neither reported by companies nor valued by capital markets systematically and broadly.

The current state of accounting for a company’s assets, developed over centuries according to evolving economic needs, is not synchronised with today’s economic reality. If this less than full treatment of intellectual capital is continued, the associated adverse effects could be far-reaching: the cost of capital could remain inadequately high for many companies (particularly for those innovative, highly knowledge-intensive ones), investors and lenders might risk missing out on potential opportunities, and the economy on potential growth.

I couldn’t agree more. In fact, companies are going to ignore the fact that their reporting fails to mention their most important assets as long as analysts and investors allow them to (even though you would think that it was in their interest to do the best job they can in the management of their companies).

The paper recommends that companies provide a statement of intellectual capital using indicators and narrative amendments. The principles these analysts put forth for creation of these indicators include:

1. Clear link to future value creation
2. Trasparency of methodology
3. Standardization
4. Consistency over time
5. Balanced trade-off betwen disclosure and privacy
6. Alignment of interests between company and investors
7. Prevention of information overflow
8. Reliability and responsibility
9. Risk assessment
10. Effective disclosure placement and timing

I love the fact that this is coming from the analysts. I hope we can get this message to American analysts too!