Author: Holmen, Jay
Date published: October 1, 2011
Journal code: CSFJ
It is widely accepted that the financial reporting model as it currently exists is seriously flawed. The Jenkins Committee (AICPA, 1994) recommended that financial reporting in the US move toward a model of business reporting that includes financial and nonfinancial information, management's analysis of this data, and forward looking information. Among the suggestions are product quality, cycle time, innovation and employee satisfaction (page 143). Research has demonstrated that intangible value drivers have an effect on financial outcomes at both the firm and market level (see Ittner and Larcker, 1998; Ashton, 2005 for a review of this literature). The Financial Accounting Standards Board documented voluntary disclosures companies were currently making (FASB, 2001). Included in these disclosures was information about intangibles that are not currently recognized by traditional financial statements. Finally, Eccles, Herz, Phillips and Keegan (2001) documented a large reporting gap between what non-financial measures are desired by managers, analysts, and investors, and what is provided. Included in these non-financial measures are intellectual capital measures.
Coinciding with this research on nonfmancial measures and intangible assets has been research in intellectual capital. Much of the groundbreaking work in intellectual capital has occurred in Sweden and Denmark. Edvinsson and Malone (1997) Mouritsen, Larsen and Bukh (2001), and Edvinsson (2002) describe the approach to intellectual capital developed by the Swedish insurance and financial services company, Skandia. Skandia released intellectual capital supplements to the corporate interim and annual reports published between 1994 and 1998. Skandia divided intellectual capital into two major components: human capital and structural capital. Structural capital was further divided into customer capital and organizational capital; organizational capital was broken down even further into process capital and innovation capital.
Denmark has also been a leader in setting guidelines for intellectual capital reporting. In the late 1990s, a variety of research reports investigated what types of intellectual capital reporting was occurring (DTIDC, 1997; DATI, 1999, 2000; DMSTI, 2002). In 2001, the Danish Financial Statements Act required disclosure of intellectual assets for medium and large enterprises (KPMG, 2002). Subsequent to the adoption of the Financial Statements Act, the Danish Ministry of Science, Technology and Innovation published several reports pertaining to intellectual capital statements, one providing guidelines for the preparation of intellectual capital statements (DMSTI, 2003 a) and one proposing a method of analysis (DMSTI, 2003b). A number of studies have documented Danish intellectual capital disclosures including Bukh, Mouritsen, Johansen and Larsen (2001),Bukh, Nielsen, Gormsen and Mouritsen (2005), Radu (2005) and Nielsen, Bukh, Mouritsen, Johansen and Gormsen (2006).
This study focuses on the disclosure of intellectual capital indicators by Danish companies. Danish companies are used in this study for several reasons. First, Denmark has experimented with intellectual capital disclosure since the late 1990s and has a longer history of disclosure than many other countries. Second, formal guidelines for intellectual capital disclosure have proceeded through several iterations; the first guidelines were published in 1999 by the Danish Agency for Trade and Industry; revised guidelines were published in 2003 (DATI, 1999, 2000; DMSTI, 2003a). These guidelines explicitly provide a linkage between a company's strategy and the indicators disclosed. Third, Danish companies have a responsibility to disclose intellectual capital resources (knowledge resources) under the Financial Statements Act if the resources are "of special importance to future performance" (Danish Financial Statements Act, June 2001, Section 99(2)). Given this rich history of disclosure, can US companies adapt the approach for the reporting of nonfmancial information?
INTELLECTUAL CAPITAL DISCLOSURE FOR DANISH ENTERPRISES
For most countries, intellectual capital disclosure is voluntary. In 2001, Denmark adopted the Financial Statements Act which required a supplemental disclosure of knowledge resources for certain enterprises. (Danish Financial Statements Act, June 2001). The act classifies entities into four classes, A through D. Class A consists of sole proprietorships, Class B includes "small" enterprises (less than 50 employees, revenues of less than 40 million DKK, or a balance sheet total of less than 20 million DKK), Class C includes medium-sized and large enterprises, while Class D includes state-owned public companies and companies with securities listed on a stock exchange. Class A and B enterprises are not required to disclose knowledge resources. Class C and D enterprises are to include disclosure in the Management Review section and should describe "the enterprise's knowledge and know-how resources if they are of special importance to its future performance" (Danish Financial Statements Act Section 99(2), see also KPMG, 2002).
The Danish Ministry of Science, Technology and Innovation has published several reports pertaining to intellectual capital statements, one providing guidelines for the preparation of intellectual capital statements (DMSTI, 2003 a) and one proposing an analysis model (DMSTI, 2003b), The guidelines propose that an intellectual capital statement consists of four elements: a knowledge narrative, a set of management challenges, a set of initiatives, and a set of indicators. The analysis model has as its goal providing an overview of an enterprise's intellectual capital, including the stock of resources, the initiatives or activities, and the resulting effects. (DMSTI, 2003b; Nielsen, Bukh, Mouritsen, Johansen, and Gormsen, 2006). The model has two major dimensions. The first dimension categorizes the knowledge resources. Typically, four categories are used: employees, customers, processes, and technologies. These are analogous to the common intellectual capital terms human capital (employees), external structural capital (customers) and internal structural or organizational capital (processes and technologies).
The second dimension reflects the composition, acquisition, and use of these four categories of resources. The composition of the resources is termed resource indicators and reflects the company's stock of knowledge resources and attributes the company can manipulate.
Resource indicators are a measure of what the company has. The acquisition of the resources is termed activity indicators and describes what is being done. Activity indicators are normally phrased in action terms and reflect what the company does with the resources it has. The use of resources is termed effect indicators and describes the consequences of the development and use of knowledge resources. Effect indicators address the question what the company gets out of the resources.
The key emphasis of this analysis model is its focus on the indicators for intellectual capital. Most of the prior studies have used content analysis to study the frequency of disclosure of intellectual capital concepts by focusing on words or phrases (for examples see Vergauwen and van Alem, 2005; Vergauwen, Bollen and Oirbans, 2007; or Whiting and Miller, 2008). This focus on terminology would put an emphasis on the reporting of the first three components of the Danish guidelines: the knowledge narrative, the management challenges and the initiatives. By studying the indicators presented, this study's emphasis will be on a micro-level of the intellectual capital being disclosed, rather than a broader macro-level of disclosure.
Although the Danish Financial Statements Act requires disclosure of intellectual capital "if they are of special importance to future performance," there is no required approach to making this disclosure. Class C and D enterprises are not required to prepare separate intellectual capital statements, but some do. Enterprises are not required to present lengthy descriptions of their intellectual capital, but some do. Enterprises are not required to disclose the indicators used to measure their intellectual capital, but some do. It is evident, therefore, that enterprises disclose intellectual capital to a greater degree than is required by Danish law. In addition, Class A and B enterprises also disclose intellectual capital voluntarily. Signaling theory may help to explain this voluntary disclosure. Signaling theory posits that an enterprise will signal positive information to investors and other stakeholders through the annual report and supplemental disclosure. Voluntary disclosure may help the stakeholders to assess the future value creation activities (Edvinsson and Malone, 1997; Van der Meer-Kooistra and Zijlstra, 2001; Williams, 2001). Abeysekera (2006) also proposes using a political economy of accounting (PEA) perspective. PEA argues that firms may provide disclosure in a way that sets and shapes the agenda of the debate. Indeed, Bukh (2003) states that part of the original motivation for developing guidelines in Denmark was to facilitate small and medium-sized firms' access to financing. The PEA perspective posits that differences in intellectual capital disclosure may arise due to political and economic differences as well as due to social differences.
SAMPLE SELECTION AND QUESTIONS
Since the focus of this study is exploratory, a random sampling of companies was not used. Companies were identified that had disclosed indicators for at least two years between 2000 and 2006. A total of 16 Danish companies were identified. Of the 16 companies, 8 were corporations, two of which were small enterprises (Class B). The other 8 companies were either co-operatives, not-for-profits, public or governmental agencies, or a small partnership. The sample companies spanned a range of very small companies (fewer than 50 employees) to very large corporations (in excess of 5,000 employees). Five of the companies were in the information technology industry, three were financial firms (primarily insurance and pension), two were engineering consulting firms, two were research centers, and one each in health care, energy, education, and legal. Table One presents characteristics of the sample companies.
Of the 16 companies, four have disclosed intellectual capital indicators for the entire seven year span 2000-2006; another four companies have disclosed for the years 2001-2006. The remaining eight companies have disclosed for between two and five years. There are a total of 79 statements for these 16 companies. Twelve of the companies have disclosed intellectual capital prior to the 2003 DMSTI guidelines, the remaining four companies began disclosing in 2003 or later. Seven of the companies release statements in English, the remaining nine companies release their intellectual capital statements in Danish. Of the total 79 statements available, 1 1 disclosed intellectual capital indicators in the Management Review section only; 48 used a separate intellectual capital section of the annual report to disclose the indicators, and 20 disclosed intellectual capital in a stand-alone intellectual capital report that accompanied the annual report.
Table Two presents the reporting years, the language of the disclosure, and the location of the disclosure.
The first question of this study considers the amount of intellectual capital disclosure and the type of disclosure. Are there differences between companies as to the amounts of disclosure (the number of indicators being presented)? Are there differences between companies as to the type of disclosure (is there the same pattern in the types of indicators being used [effect, activity, resource] and the same pattern in the categories of indicators [employee, customer, process, technologies])?
The second question concerns the type of companies that disclose intellectual capital indicators. Do the Class C and D corporations disclose more intellectual capital indicators than the other enterprises? Are there differences in the amount and type of disclosure? These are the entities required to disclose by the Financial Statements Act.
The third question concerns the location of the intellectual capital disclosure. Are there differences in the amount and type of disclosure between companies that locate the disclosure in the Management Review versus those that disclose in a separate section of the annual report or in a stand alone supplement
The fourth question relates to changes in the reporting practices since the revised guidelines were published by DMSTI in 2003. Do the statements released post 2003 (after revised guidelines) contain more disclosure than reports released pre 2003?
The total sample of 16 firms yields the following results for the number of indicators reported:
The 79 intellectual capital statements contained an aggregate of 2,447 indicators. Of the aggregated indicators, 54.5% of the indicators are employee indicators, 26.1% are customer indicators, 16.6% are process indicators and 2.8% are technology indicators. The indicators can also be broken down as follows: 37.0% are effects indicators, 32.8% are activities indicators, and 30.2% are resource indicators.
The average number of indicators per statement is as follows:
Whiting and Miller (2008) reported on comparative frequencies for categories of intellectual capital indicators as reported in nine prior studies. All of the studies found that external structure capital attributes have the highest frequency of disclosure. Percentages ranges from a low of 37% to a high of 49%. Internal structure capital attributes ranged from 25-37% while human capital attributes ranged from 10-36%.
The Danish companies in this sample disclose anywhere from 1 .5 to 5 times the number of employee indicators reported by Whiting and Miller (2008). This may be due to the political and economic environment in Denmark and supports a PEA perspective. A number of the companies in the sample have labor representatives serving on the board of directors. At the same time, the number of customer, process and technology indicators disclosed in the sample are less than have been observed in other studies. This may be due to the absence of brand disclosures observed in the Danish sample but present in other studies.
Analysis of Questions
The first question asks whether there is consistency in disclosure of indicators amongst companies. This question can be tested using a factorial analysis of variance. Since the number of years that any given company disclosed intellectual capital varied, the average number of indicators for each company was used. Thus, there were 16 observations (one for each company) for the analysis of variance. The variable for equality of number of indicators presented for each company is significant at a level of < .01. The conclusion is the number of indicators disclosed varies amongst companies.
Are there differences in the three types of indicators (effects, activities, and resources) as well as differences between the four categories of indicators (employees, customers, processes, and technology)? The test for equal means of each type of indicator is not significant, the p-value is 0.91. This leads to a conclusion that there are no differences between the average number of indicators disclosed for effects versus activities versus resources. The test for equal means for each category of indicator however is significant at the <.01 level. It can therefore be concluded there are statistically significant differences in the average number of indicators presented for the four categories, but no significant differences between the types of indicators.
The second question of interest is whether the Class C and D corporations in the sample disclose more intellectual capital indicators than the other enterprises. Are there differences in the amount and type of disclosure? The following table presents the number of indicators disclosed along with the average number of indicators.
Notice that the Class C or D corporations disclose on average 3 1 .66 indicators while the other enterprises disclose an average of 30.51 indicators. A factorial analysis of variance yields similar results to that for the first question (there is a significant difference in the disclosure by category of indicator but not by type of indicator); additional analysis shows that the type of company does not have a significant effect on the average number of disclosures (p = .85).
The third question concerns the location of the intellectual capital disclosure. Are there differences in the amount and type of disclosure between companies that locate the disclosure in the Management Review, a separate section of the annual report, or as a stand alone supplement? The following table presents the number of indicators disclosed along with the average number of indicators.
The companies that disclose the intellectual capital indicators within the management review portion of the annual report disclose on average only 9.73 items, while companies that disclose the indicators in an intellectual capital section disclose an average of 33.15 and 37.45 items. A factorial analysis of variance yields a significant difference between the management review disclosers and the section disclosers (p < .001). The difference between the two forms of section disclosers is not significant (p = .19).
The fourth question addresses whether there are differences in the disclosure of intellectual capital after the Danish revised guidelines were published in 2003. This can be analyzed by comparing the years 2000-2002 and 2004-2006.
The average number of indicators reported over time has decreased for all categories with the exception of employees/activities, customers/activities, and processes/resources. A factorial analysis of variance was again performed with an additional variable to reflect the pre-2003 and post-2003. Once again, the type of indicator breakdown (effects, activities, resources) was not statistically significant while the category of indicator (employee, customer, process, technology) was significant. The time (pre-2003/post-2003) variable was not statistically significant (p = 0.1985). It can be concluded there are no significant differences in the disclosure of indicators after the revised guidelines were issued.
Analysis of Indicators
The maximum number of indicators for any one company is as follows:
This table can be interpreted as follows. The maximum number of employee effects indicators reported by any of the 16 sample companies was 21, the maximum number of customer activities indicators reported by any of the 16 sample companies was 38, etc. The maximum number of employee indicators reported by any of the 16 sample companies (whether the indicators are an effects indicator, an activities indicator, or a resources indicator) was 29, the maximum customer indicators was 45, etc. The maximum number of effects indicators reported by any of the 16 sample companies (whether the effects indicators are employee, customer, process or technology) was 39, the maximum number of activities indicators was 79, and the maximum number of resources indicators was 29. In aggregate, the maximum total number of indicators reported of any type had a range of 40 to 103. The minimum number of indicators reported in any given year ranged from 1 to 13 indicators.
Several indicators were consistently reported across companies. All 16 companies disclosed an indicator for number of employees. Nine of the companies disclosed some form of indicator of either employee satisfaction or employee satisfaction with their job. Another nine companies disclosed an indicator for overall customer satisfaction. Five companies disclosed an indicator for the number of customers. Table Three presents a categorization of the specific indicators disclosed.
CONCLUSIONS, LIMITATIONS AND FURTHER RESEARCH
The main conclusion of this study is there are differences among the number of indicators and the category of indicators being used in formal intellectual capital reports by Danish companies. The average number of indicators of intellectual capital differs at a statistically significant level as does the relative pattern in the categories (employee, customer, process, technology) of indicators presented. There was not a statistically significant difference in the patterns for the types (effects, activities, resources) of indicators presented. There also was not a significant difference in the number of indicators disclosed by Class C or D corporations versus the other forms of enterprises. There was, however, a significant difference in the location of the disclosure within the annual report. Companies that disclosed intellectual capital as part of the Management Review section of the annual report presented significantly fewer indicators than did the companies that presented disclosure as either an extended note to the report or as a standalone intellectual capital statement. Although more disclosure was presented when a stand-alone statement was presented, the difference between that and the extended note was not significant.
There was not a significant difference in the intellectual capital reporting between the two time periods investigated. There was an observed decrease in the indicators disclosed in the time period following the guidelines published by the Danish Ministry of Science, Technology and Innovation in 2003, but the decrease was not statistically significant.
There are a number of limitations to this study. First, the sample is not a random sample of all companies that disclose intellectual capital indicators. Every firm that was identified as disclosing intellectual capital was included in the sample. Second, the sample size is only 16 firms. This limits the power of any statistical tests on the population of reports. Third, the sample was restricted to companies that made their intellectual capital statements available to the general public via the internet.
Further research may include expanding the sample size beyond the 16 firms. An additional question is whether the formal reporting of intellectual capital indicators has any relationship with quantified measures of the value of intellectual capital (for example, see Andriessen, 2004; Ashton, 2005; or Pulic, 2000). Extensions could also be made to relate formal intellectual capital statements and market capitalization (for example, see Abdolmohammadi, 2005). A third extension could be to compare Danish intellectual capital reporting with other countries (for example, the German Federal Ministry of Economics and Labour (Alwert, Bornemann and Kivikas, 2004) has proposed guidelines for intellectual capital reporting by small and medium sized enterprises).
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Jay Holmen, University of Wisconsin - Eau Claire