The Role of the Intangibles Information Gap in the Financialization of US Corporations

The financialization of US corporations has been aided by the lack of information on intangibles (which make up 70% of total corporate value). Filling in the gap is a big part of the solution to the problem.
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My comments at US Corporations in the Recovery & Beyond

The conference kicked off late yesterday. On our panel, we each made short introductory remarks and then had a great discussion.

The folks from Nypro had an amazing story to tell. Owned by the sixth largest ESOP in the country, the employees have had $300 million in wealth gain in the last 15 years. They combine ownership with complete financial transparency–an ESOP needs both to succeed. They feel that they have been successful in thinking long term.

Here are some of the thoughts that I covered in my remarks:
I was in a meeting with a client recently. The company is a division of a multi-national that sells a home healthcare product that more often than not, they install in their customers’ homes. A number of years ago, they outsourced their installation staff. In the years that I have known them, I’ve heard remarks about smelly, unattractive people showing up at people’s homes.

There’s a new guy in charge-used to be in manufacturing-that is changing how they think about these low-paid but very valuable people. Now everyone sees them the face of this company in the market.

So now they are giving them training on how to teach older people to feel comfortable with the service, handling objections when the customer is waffling on the service, on market development (to drop brochures to the super when they are in an apartment building),.

Bottom line, they are investing in these people and viewing them as an asset rather than an expense. And they are converting them into knowledge workers, empowered and enabled to think on their feet and create value for the company.

This isn’t that different from stories I have heard in manufacturing companies who have shifted how they see their production employees. These are stories on the ground how the shift to the knowledge era has changed work not just at the high tech, high end-it’s everywhere.

Today, 70% of the value of the average business comes from knowledge intangibles. Michael Mandel is here and he has written about this at a macroeconomic level. The same information gap that exists on a macro level also exists on a micro level.

But accounting, the markets and limitations of industrial-era management tools still in use all conspire against recognizing and leveraging this value.

70% of the value of companies is invisible to investors, managers and stakeholders. It has forced us to see companies as income statements rather than balance sheets.

A number of the other speakers here are addressing the issue of financialization of corporations. My perspective is that this financialization is a logical outcome of the short-term thinking that results from looking only at income statements.

But it’s actually very simple to address this once one admits it is a problem. Good work has been done for close to 20 years (mostly in Asia and Europe) to identify the sources of intangible value. They are:

• People (human capital)
• Relationships (relationship capital)
• Processes (structural capital)

Every company has a unique combination of people, process and relationships that work as a system to create value for its customers. This system is the “factory” of our era.

These factories are amazing. They are infinitely scalable. They are flexible and dynamic. And they can be a hotbed of innovation. —But only if they are understood as factories, as assets.

In the eye of an income statement, they are still expenses. And an expense mindset thinks outsourcing to improve this year’s earnings is the right solution.

If we cannot arm managers and investors with information about more than just today’s earnings, we will never achieve the level of innovation that we need to fuel the growth of our economy. Sustainable human resources practices are dependent on a longer-term viewpoint.

There are many academics in this audience. Many have not heard the IC perspective before. I look forward to more conversations today. I plan to Tweet if possible.

The Enduring Value of IT and Process Investments

Yesterday, I had a meeting with some consultants who told me the story of a group of IT and accounting people from one of their clients screaming at each other because they could not find common ground to communicate about the cost and ROI of IT investments.

Then, last night, standing in the parking lot outside the Boston KM event, I had a long chat with an engineer who has been around tech and business for decades. He was very active in the Y2K adjustments (yes, that was a decade ago?!). He volunteered to me that people still don’t have a disciplined way of tracking their IT and processes.

This is one of the big reasons that IT and accounting people end up screaming at each other. It’s not that the individuals are at fault. It’s that they are working in a broken system. Read more

Thoughts on the Shift to the Knowledge Economy

I had a great time last week with the Association for Strategic Planning in Boston. I shared with the group a summary of the shift to the knowledge era and then led them in an exercise to talk about the significance of this shift to business.  Having been involved with ASP and well as the Institute of Management Consultants (IMCNE), I told the organizers that I wanted to avoid being a talking head–but rather to engage the group in a conversation. And it worked really well!

The group was great. It included consultants and corporates as well as grad students and professors from Suffolk University’s business school (our hosts). Read more

Accounting for Intangibles – The Income Statement is Not the Answer

I guess it’s time to talk about Accounting for Intangible Assets: There is Also an Income Statement by Stephen Penman. When this new paper first came out from the Center for Excellence in Accounting & Security Analysis at Columbia University, I decided to ignore it as an apology for current accounting standards–which are completely inadequate for the knowledge era.

But now the paper is getting more attention so I feel the need to answer it.

We are not talking about some theoretical accounting issue.  70% of the value of the average M&A deal is intangible. 60% of the average corporate investment is intangible. 50-80% of the average public company is intangible. That means that intangibles are ignored by accountants (the only real exception is in the case of a merger, when the lack of understanding ends up as 50% of the purchase price going to goodwill). None of this is helpful to the cause (and stated mission of Columbia’s center) of “excellence in accounting and security analysis.” Read more

Goodwill is a Metric of the Failure of the Accounting Model

At least once a week, I see articles or blog posts bemoaning goodwill. One of the latest was an article in Business Week entitled Magic Tricks on the Corporate Books. This article is typical in its interpretation that goodwill represents funny money. It is often also assumed that management teams are playing games with goodwill. While this may sometimes be the case, goodwill usually represents actual, identifiable value. The problem is that no one really knows when and where this value exists. The accountants could produce data but they don’t. Read more

Accounting for Intangibles Represents Strategic Opportunity for Corporate America

Thanks to Nir Kossovsky for his post on the Mission: Intangible Blog pointing out the opinion piece by long-time corporate governance leader, Nell Minow,  in the Financial Times last week entitled, Impresarios on the Board Are a Bad Sign. Minow makes the case that

Opponents of post-meltdown reforms to corporate governance are trying to hold back change by focusing on Washington. The US Chamber of Commerce is spending $100m (€69m, £63m) to try to defeat any substantive reforms. They are missing the point. No matter what happens in Washington, the market is forcing through significant and pervasive reforms. The companies that first understand that will benefit from a lower cost of capital and more committed long-term investors. As we understand better the mistakes of the past and the challenges ahead, fund managers and analysts will look at “new fundamentals”, four elements that will become as important as cash flow and return on investment. Read more

Alternative to Moody’s and S&P Still Missing Intellectual Capital

There is a brief but powerful article in Wired this month about a crowd-sourced alternative to traditional credit rating agencies, Rick Calculators: Forget Moody’s and S&P. These guys know how to beat both.

The article features Freerisk.org, which provides XBRL data from SEC filings to what the article calls “a volunteer army of finance geeks.” It quotes co-founder Jesper Andersen:

The problem is too big to leave to private profit centers.

This is a great application of the power of the knowledge era. And it’s a critical first step. But it won’t be enough.

Remember that the majority of reporting in the data everyone uses (including Freerisk) is produced under a financial accounting paradigm that is broken. Modern accounting cannot describe the roughly 70-80% of every company’s value that is off balance sheet. For some reason, everyone inside our financial system continues to put up with a system that focuses on tangible assets that are NOT the key drivers of earnings, competitive position or future outlook of a company.

We need to get this intellectual capital into the reporting stream. The first step is for companies to learn how to see and measure these assets internally. Some of our ideas on how to do this are in the award-winning article I wrote last year for the Emerald Business Strategy Series, Management 2.0: Leveraging the Growing Intangible Side of Your Business. I welcome your thoughts.

SBA Goofs on Intangibles

Thanks to Donald Todrin for his post The SBA puts another stake in the heart of the small business world. He explains the the Small Business Administration (SBA) issued new guidelines on February 7th saying that no more than 50% of a 7(a) loan should be used to finance goodwill.

Given that goodwill is accounting’s (very inadequate) way of keeping track of the intangibles that drive business performance today, this ruling means that the SBA will not finance many of the kinds of business we need to increase innovation and growth in our economy–the businesses that leverage knowledge. This isn’t an abstract thing. Every business with a computer can and should begin to create more and more value without investing in the hard assets that appear on the balance sheet. Read more

Danger: Your professors may be sucking you into their time warp

I was recently invited to  speak to an MBA accounting class about how the knowledge economy represents such a huge challenge (and opportunity) to the field of accounting. The students and the professor were very receptive and open to the fact that huge changes are inevitable in accounting if it is going to remain relevant over time.

However, I was struck as I overheard lessons Read more

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