2664
THE DEVELOPMENT AND EVALUATION OF INTELLECTUAL CAPITAL INDEX IN MALAYSIA
Shamsuddin Amanuddin ¹ ٭, Zainal Abidin Zubaidah ², Huang Ching Choo ³
¹ Department of Accounting, Universiti Tenaga Nasional UNITEN ² Faculty of Accountancy ARI, Universiti Teknologi MARA
³ Faculty of Accountancy ARI, Universiti Teknologi MARA
Abstract Intellectual Capital IC, a value creato
r of today‟s economy, is of critical importance to a company‟s long-term sustainability, profitability and growth.
Though the value of companies has been shifting from tangible to the intangibles, many studies indicate that IC or IC components is not fully
measured by the traditional financial statements due to its intangible nature see for example Guthrie Petty, 2000; Williams, 2001. As IC enables higher
corporate value which results in better financial performance, it is essential to measure or value IC via a more creative tool such as IC Index Bontis, 2004 or
Rating Edvinsson, 2002. An IC IndexRating provides management with a basis for optimising competitiveness of its companies by focussing on the
potential value of IC. It also functions as a foundation to measure IC and its components maximising profits for companies. It should also help various
groups in comparing the potential IC values of companies.
The research will study the effect of intellectual capital on companies‟ performance in the Malaysian business environment. Components of IC are
introduced and linked to the companies‟ competitiveness andor performance. The intent is to provide an exploratory foundation for the development of
systems and processes useful for meaningful management of intellectual assets. Finally, the study shall make recommendation based on empirical findings for
external reporting of intellectual capital. Keywords
: Intellectual Capital, Malaysia
2665 ________________________________________________________________
_______ Corresponding author:
Shamsuddin Amanuddin, College of Business Management and Accounting, Sultan Haji Ahmad Shah Campus, Universiti Tenaga Nasional, 26700 Bandar
Muadzam Shah, Pahang, MALAYSIA Email:
Amanuddinuniten.edu.my
CHAPTER 1: INTRODUCTION 1.1
Introduction
Intellectual Capital IC, a value creator of today‘s economy, is of critical importance to a company‘s long-term sustainability, profitability and growth.
Though the value of companies has been shifting from tangible to the intangibles, many studies indicate that IC or IC components is not fully
measured by the traditional financial statements due to its intangible nature see for example Guthrie Petty, 2000; Williams, 2001. As IC enables higher
corporate value which results in better financial performance, it is essential to measure or value IC via a more creative tool such as IC Index Bontis, 2004 or
Rating Edvinsson, 2002. An IC IndexRating provides management with a basis for optimising competitiveness of its companies by focussing on the
potential value of IC. It also functions as a foundation for modern business control system supplying clear and measureable goals to measure IC and its
components maximising profits for companies. It should also help various groups in comparing the potential IC values of companies. Thus, the old axiom
that ―something gets measured, gets managed‖ holds valid. Review on intellectual capital literature which has focus on performance
measurement, shows that most of the studies concerning performance measurement have examined mature listed companies and had market value as
one key indicator see e.g. Bontis et al. 2000; Hurwitz et al. 2002; Chen et al., 2005. Many of the studies support the hypothesis that intellectual capital has a
positive impact on firm‘s financial performance and market value. There are of course contradictory results as well suggesting that more investment in
intellectual capital is not always better Huang and Liu, 2005 and that not all
elements of intellectual capital have positive impact on firm‘s financial performance Wang and Chang, 2005; Firer and Williams, 2003. Contradictory
results may stem from the facts that the analyzed firms are from different regions, they are not in the same field of business or firms may undergo
divergent growth stage.
The critical competitive importance of intellectual capital in today‘s economy inidicates a need for high performance systems to manage them. Recent
advances associated with total quality management, reengineering, learning organizations, and other initiatives have accomplished much. However, review
from literature indicates that the management of intellectual capital is, at best,
2666 ad hoc in most organizations. One reason is that traditional accounting systems
are not well equipped to measure or monitor most elements of intellectual capital. Anoher reason is that the management of intellectual capital is
considered by many as synonymous with workforce management. However, intellectual capital encompasses more than people and, therefore, requires a
more comprehensive approach. 1.2
The Proposed Study
The research will study the effect of intellectual capital on companies‘ performance in the Malaysian business environment. Components and
elements of intellectual capital are introduced in detail and linked to the issues raised in the analysis of competitiveness andor performance. In addition,
methods of measuring intellectual capital at both the components and organization levels shall be presenteddeveloped. The intent is to provide an
exploratory foundation for the development of systems and processes useful for meaningful management of intellectual assets. Finally, the study shall make
recommendation based on empirical findings for external reporting of intellectual capital. The core of the thesis is to develop an intellectual index or
rating for Malaysian companies. 1.3
Significance of the Study
The results of this research should supplement interest groups in investing decisions and company valuations. The result which links IC value to
performance and market value of companies will be used for prediction. The findings of this research will aid the profession in a more systematic external
reporting of IC like disclosing IC Index in the annual reports in the future. 1.4
Summary
This research hopes to develop an IC IndexRating for Malaysian companies. The result of this research should help interest groups in investing decisions and
company valuations as well as make comparison among them. The result will also link IC value to performance and market value of companies.
This research also intents to make recommendations to the Accounting profession for external reporting of IC in the annual reports of Malaysian
companies indicating their IC index or rating. On the next section, a short review on relevant literature is given. After this, the
research framework is considered.
2667
CHAPTER II: LITERATURE REVIEW 2.1
Introduction
Recent changes in the global economy which charaterized by complex and dynamic competitive environment have led to the importance of knowledge-
based resources as the true source in sustaining competitive advantage of the firm. With this growing need to support knowledge-based economy, the way
business is
carried out has to be reshaped as firm‘s core asset are now the intellectual capitals IC that generally made up of the combined knowledge of
human, structural, and relational resources Abdul Latif Fauziah, 2007. Following this new development, Malaysia has also embarked on a mision to
develop a knowledge-based society by launching a Knowlwdge-Based Economy Mater Plan in 2002 which outlines various strategies to accelerate the
transformation of Malaysia to a knowledge-based economy Economic Planning Unit, 2002. It aims to achieve a sustainable economic growth where
Malaysia can no longer rely on investment in capital or physical assets but rather growth must be driven by productivity and innovation supported by
effective managment of both tangible and intangible resources particularly the IC.
It is expected that the number of knowledge workers and new knowledge-based opportunities will increase in the near future of Malaysia and this new
phenomenon will force firms to further develop and manage their IC. However, other than the concern on IC management, what is equally important is that the
accounting discipline reflected in financial reporting as currently conceived can no longer provide what is being demanded by information users and investors.
The studyresearch is trying to propose here is the need for a much more broadly conceived concept of firm value reporting in Malaysia based on the
dual requirements of financial and operational reporting, and within this context, IC reporting. In Malaysia, as presently, not much is known as to the extent to
which firms in Malaysia have adopted IC management and subsequently IC reporting. Thus, it is the purpose of this research to analyse the initiatives
developed in Malaysia in relation to IC reporting practices and then propose a policy framework specifically in the development of Malaysia own IC reporting
index for a consistent and comparable IC reporting among Malaysian firms that would allow for more meaningful decision making. The practical implication
would be for enforcement bodies like Securities Exchange SE, Bank Negara Malaysia Central Bank of Malaysia, and Companies Commission of Malaysia
to use this propose IC reporting index as a guideline in setting legal requirement for mandatory operational and IC reporting. This research will also become a
reference framework in assessing information quality that is, inter alia, based on consistency, comparability, and comprehensiveness of reported information.
2.2
Intellectual Capital - Definition
A review on literature indicates that there is a lack of a homogenous view on how to define, classify and value intangible assets or intellectual capital. It can
2668 be argued that definitions and classifications of intangible assets are made with
respect to the specific purpose of each study see e.g. Kaplan and Norton 2004; Bontis and Fitz-enz 2002; Hurwitz, Lines, Montgomery and Schmidt 2002.
The literature concerning intangible assets is widely encountered in the field of business research. One remarkable research project concerning intangible
assets was the MERITUM-project
– a project funded by European Union. The project‘s final report ―Guidelines for managing and reporting on intangibles‖
2001 presents intellectual capital as a combination of three groups where intangible assets can be further derived from.
In MERITUM-
project‘s guideline intellectual capital refers to the combination of the human, structural and relational capital. A concept of intangible asset
intangible refers to a factor asset arising either from human, structural or
relational capital, which is used to create value. Human capital focuses on skills, experience, competence and innovation ability of personnel; structural
capital consists of organizational processes and systems, software and databases, business processes and brands; relational capital includes customer
reference lists, information on customer revenue potential and customer closeness. Though these elements are presented separately, they are bound with
each other Guidelines
for managing… β001; Rodov and δeliaert β00β. From management‘s perspective, intangibles are directly linked to internal
strategic decision-making, whereas the importance of intangibles for investors is emphasized in investment decision-making process. Arvidsson 2003
studied extensively strategic management and measurementaccounting literature and found intangible assets classifications being developed either for
the internal or external usage. The strategic management literature relates intangibles to the process of creating sustainable competitive advantage and
corporate value, whereas measurementaccounting literature focuses on how intangibles can be structured and measured in the financial accounting and
reporting context. This definition is of course not an exclusive one, leaving room for other definitions too. Figure 1 represents the classification structure
for intangibles suggested by Arvidsson 2003.
Figure 1. Classifications for Intangible Assets
Listing-approach, comprehensive-approach and BSC-approach represent the classifications developed for internal usage
– their origin lie in the strategic management literature. Management team and other employees involved in the
strategic decision-making processes use listing-approach to propose sub-groups and then to sort intangibles into these sub-groups. In comprehensive approach
intangibles importance in the value-creation process is emphasized and intangibles classifications are put forward as schemes, models or frameworks
developed and designed to assist in the internal strategic decision-making process. Neither listing-approach nor comprehensive-approach has a
2669 measurability dimension that BSC-approach has. BSCapproach does not,
however, try to value the intangible assets in currency units. It is distinguished from other approaches by the fact that it does not have an explicit focus on
intangibles. Nevertheless, its customer, internal-business processes, and learning and growth perspectives have had substantial influence on the
classifications of intangibles Arvidsson 2003. Three approaches described above refer to the strategic management literature
and represent the classifications of intangible assets developed for the internal usage. In a similar manner, a threefold division-approach represents a
classification developed for the external usage. Measurementaccounting literature has provided a base for this classification structure, where the
dimensions of human capital, structural capital, and relational capital are emphasized. This categorization helps firms to communicate the presence and
the importance of their intangible assets. Investors on the capital markets can
utilize this structure to evaluate the firm‘s intangible assets and to better capture a value of the firm. Though the threefold division-approach has external usage
status, its exploitation for internal use cannot be excluded Arvidsson 2003. Intellectual capital and intangible assets are often used as synonyms to describe
the non-tangible factors of production that the firms make use of. However, when accounting is considered, a definition for both terms can be drawn. The
International Accounting Standards Board defines an intangible asset as an identifiable non-monetary asset without physical substance held for use in the
production or supply of goods or services, for rental to others, or for administrative purposes. In addition, FRIS 38 prescribes that intangible asset is
a resource controlled by an enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. These
definitions draw a distinction between intellectual capital and intangible assets. The former includes all elements of non-tangible assets that the firm can utilize
in its operations; in the latter elements that the firm does not control own are excluded, i.e. some elements of human capital.
2.3
Theoretical Background to the Study
The investigation of IC reporting could probably best drawn from social and political theory most particularly the stakeholder theory and legitimacy theory.
Stakeholder theory talks about how the organization owes accountability to all its stakeholders to provide information on how the organization‘s activities
affect them Deegan, 2000. These should encourage voluntarily disclosures of IC as indicators of which stakeholders matter most to the firms and thus, those
which firms may be seeking to influence. Legitimacy theory argues that firms can only continue to exist if the society in which they are based perceived the
firms to be operating to a value system which is commensurate with the
society‘s own value system. Thus, Guthries et al β004 argue that firms with high levels of IC will be more inclined to disclose their IC as they cannot
2670 legitimize their status through the traditional symbols of corporate success, the
tangible assets. Instead, they need to communicate how the firm uses its IC to generate value.
2.4
Measuring and Reporting Intellectual Capital Practices
Efforts to reconstruct firms annual reporting to include IC indicators were spearheaded in the early 1990s by a small number of firms which took a
particular interest in thsi issue Guthrie and Petty, 2000. Annual Report is an ideal location for applying the IC model because they provide a good proxy
with which to measure the comparative positions and trends of IC between firms, industries, and countries Abeysekera, 2001.
This has been one reason why much of the published research on measuring and reporting of IC practices has used annual reports as a source documents to
ascertain the status of the IC of firms, both within countries and between countries. Among IC reporting researches published in the last few years are
located in Australia Gutrie Petty, 2000, Sri Langka Abeysekera Gutrie, 2000, and United Kingdom Williams, 2001. Most of these researches used
framework developed by Sveiby 1997 i.e. the Intangibles Assets Monitor model in undertaking their research. One of the researches conducted by Gutrie
and Petty 2000 in Australia revealed that key components of IC are poorly understood, inadequately identified, inefficiently managed and inconsistently
reported. In fact, even the Australian best practice firm is in need of a comprehension management framework, especially for reporting IC
information. There were also researches conducted in the area of human resource HR reporting, a subset of IC, in which has seen an increasing
importance in Nordic countries in the 1990s, especially Sweeden see Sveiby, 1989 where companies took a lead in this respect by publishing statements
about their HRs in their annual reports as an addition to the conventional financial statements.
In Malaysia, as presently, not much is known as to the extent to which firms in Malaysia have adopted IC reporting but there are high possibility Malaysian
firms that produce the Corporate Social Responsibility CSR reports to provide information on HR See Kamaluddin and Abdul Rahman, 2007. However, that
does not mean there is no research being conducted in Malaysia on IC as most of the exixting research has put more focus on the IC management instead of IC
reporting see Abdul Latif Fauziah, 2007. Recent study on IC is focus on the impact of the IC disclosures in the prospectus of the firms offering IPOs.
Therefore, what this research trying to propose here is the need to create a better management of IC and better quality of financial reporting among the
Malaysian companies by analyzing the initiatives developed in Malaysia in relation to IC reporting practices and propose a policy framework index
specifically in the development of Malaysia own IC reporting Index for a consistent and comparable IC reporting among Malaysian firms that would
allow for a more meaningful decision making.
2671
2.5 Development of Intellectual Capital Reporting
Measuring and assessing IC by firms have become more important with the adoption of International Financial Reporting Standards IFRSs by many
countries including Malaysia. The prudent approach taken by IFRS especially in recognizing assets such as applying impairment test on assets and writing
off intangibles which cannot be objectively verified in reference to an active market has altered the reporting value of firms rather than the fair value of the
firm Abeysekera, 2007. This approach has also
increased the ―unexplained‖ gap between the fair price and the reported value net book value of the firm.
Since investors are not fully aware of the gap between fair value and the reported value, this information gap creates two broad classes on investors:
those that have access to information relating to the ―unexplained gap‖ perhaps shared at private meeting and those that don‘t εary et al, β00γ. As investors
have access to information that explicates the ―unexplained gap‖ can make better economic decisions as compared to those without the information, the
need for better reporting has increased which lead to the development of external reporting that include IC Reporting. This new development could
possibly create a competitive advantage to those firms that are able to produce such report.
Firms have always used tools to assess their assets and with the increasing demand for IC reporting, a demand for a new managing and measuring tools for
a special type of intangible resources, such as organizational knowledge, has
existed. Among tools being introduced for managing firm‘s IC is the Skandia Navigator, the Intellect Model, and the Intangible Assets Monitor.
Skandia Navigator model proposed by Edvinson and Malone 1997 exposes five scopes: financial, client, human, processes, and renewal and development
as elements of the IC system, proposing for every one scope, a set of indicators. The model uses indicators of absolute measurement and efficiency indexes of
IC. The main contribution of this model is its integrity, looking at the financial and non-financial perspectives of the organization that allows the estimation of
market value of the firms Bontis, 2001. The Intellect Model 1998 developed in Spain in the workgroup of European Institute proposed three areas of IC:
human, structural, and relational. Each area tries to give a preliminary order in elements which are then concreted in measurement indicators. The Intangible
Assets Monitor Sveiby, 1997 commonly described as consisting of three capital categories: internal, external, and employee competence human capital.
In an IC research conducted by Abeysekera 2007 on developed and developing countries, this IC model has been further divided into sub-categories.
For instance, human capital was clustered into seven sub-categories i.e. training and development, entrepreneur skills, equity issues, employee safety, employee
relations, employee welfare, and employee-related measurements. The training and development sub-category normally comprises know-how, vocational
qualifications, career development and training programs while the equity issues can be traced down to issues relating to race, gender, religion, and
disability. The employee relation covers union activity, employees being
2672 thanked, employees being featured and employee involvement in the
community whereas the employee welfare sub-category consists of employee compensation plan, employee benefits, and employee share and option
ownership plan. Lastly, the employee-related measurements sub-category comprises value-added by employees and executives, employee numbers,
professional experience, eductaion levels, expert seniority, and age of employees Subbarao and Zeghal, 1997.
The next section shall illustrate the research methodologies that will be carried out throughout the study.
