How effective is financial reporting of intellectual capital? Empirical Evidence for Portugal

Abstract

Several authors (Wallman, 1995; Canibano, Ayuso and Sánchez, 1999; Lev and Zarowin, 1999) are concerned with the fact that accounting and financial reporting do not follow the rapid changes of the business world. The existence of intangible resources that are not recognised as assets is a problem that tends to get worse, since these assets tend to increase and to become the most significant assets of modem enterprises (Wallman, 1995). Several researchers have been using the market to book value (MV/BV) ratio as a proxy for intangible resources not recognised as assets. According to Brenan and Connel (2000), substantial differences between firms' accounting and market values are an indicator of the presence of unrecognised and unmeasured assets in the balance sheets of those firms. The assets related with intellectual capital represent a substantial proportion of this discrepancy. In this paper, we estimate the MV/BV ratio during the 1995-1999 period, using a sample of Portuguese firms whose stocks are quoted in Lisbon Stock Exchange. We conclude that the average ratios are always greater to one. All the ratios increase during the five-year period of the analysis. We also verify that the services sector presents superior average ratios comparatively to the industry sector. Using the OECD classification for the manufacturing sector and the results of a survey on innovative activities in Portugal (OCT 2000), we estimate the evolution of the above referred ratio for different categories of firms according to technological innovation. We conclude that firms with high and medium-high technological innovation also present a larger growth in the MV/BV ratio. These results are consistent with the hypothesis that the current accounting model is losing relevance in the capturing intellectual capital, so there is an increasing gap between firms' market and accounting values. Based on the same sample, we analyse the explanatory power of the accounting variables using linear regressions, expressing firm's market value as a function of its book value and earnings, based on panel data.