Accounting for Intellectual Capital: The Relationship between Profitability and Disclosure

Executive Summary One hundred fifty high-technology companies were examined to determine if management's disclosure level of intangible assets was influenced by firm performance. Our research supported a statistically significant inverse relationship between the level of intellectual capital disclosure and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) for both the fiscal years 2000 (r = -.1849, p ≤ .05) and 2004 (r = -.1515, p ≤ .05), and Net Income for the 2000 (r = -.2307, p ≤ .01) but not 2004 (r = -.0941, ns). Many start-up firms in the high-technology sector experience low to negative earnings, due in part to the treatment of intellectual capital as an expense by the traditional accounting model. This study suggests management may choose to increase the level of their intellectual capital disclosure in an effort to explain the low performance metrics or to compensate for the failure of the traditional accounting model to capitalize costs associated with the development of intellectual capital resources. As the firm grows, management may want to reduce the level of disclosure to conceal sensitive strategic information in order to maintain a competitive advantage. Introduction As our society has moved from the industrial age to the information age, the importance of intellectual capital in business has grown. During the industrial age, it was the cost of property, plant, equipment and raw materials that was essential to the viability of a business. In the information age, it is the effective use of intellectual report on their intangible assets, they use narrative disclosures in the annual reports because traditional accounting standards and practices are insuficient to account for intellectual capital (Bharadwaj, 2000; Meso & Smith, 2000; Spender, 1996). The purpose of this study is to examine how the firm's performance is related to management disclusure of its intellectual capital. While intellectual capital is relevant to finacial and acccounting professionals, its disclosure is an important and complex issue for management. For example, management may use a disclosure strategy to convince external parties of the underlying value of the firm. On the other hand, management may dicide to constrain its transparency in order to protect certain important information (Welch & Rotberg, 2006). Bharadwaj (2000) argues that a firm's most valuable and important resources are its intellectual capital or intangible assets. Tangible assets can be easily imitated or acquired in the open market. Therefore, by definition, they cannot be strategic assets or advantage creating resources (Meso & Smith, 2000; Spender, 1996). Conversely, intellectual capital is most often internally generated and embedded in the skills and experience of its employees, its processes, procedures and routines, and its information repositories. Because of these characteristics, they are unique, difficult to imitate and valuable. In other words, they are advantage-creating resources (Bharadwaj, 2000; Matusik & Hill, 1998; Prahalad & Hamel, 1990). Intellectual Capital Numerous terms have been used to denote what is often referred to as intellectual capital. Among these are intangible assets, intangibles, intangible resources, invisible assets, and intellectual property (Kaufman & Schneider, 2004). In addition to various terms being used to represent the intellectual capital construct, numerous definitions have also been used to define the concept with each definition emphasizing different attributes of intellectual capital. The intellectual capital model that appears to have garnered the widest acceptance among academicians has the following three components: (a) human capital, (b) structural (organizational) capital, and (c) relational capital (Canibano, Garcia-Ayuso & Sanchez, 2000; Ordonez de Pablos, 2002; Ordonez de Pablos, 2003; Ordonez de Pablos, 2004; Sanchez, Chaminade & Olea, 2000). …