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The Role of theIntangibles Information Gap in

the Financialization of the American Corporation

Mary AdamsI-Capital Advisors

Response to New School discussion on

US Corporations in the Recovery and Beyond

Friday, April 23, 2010

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Corporate value is increasingly intangible

Research: Ned Davis

Components of

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2,000

4,000

6,000

8,000

10,000

12,000

14,000

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Market Premium

Intangible Book Value

Tangible Book Value

Components of S&P 500® Market Capitalization

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2,000

4,000

6,000

8,000

10,000

12,000

14,000

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

S&P 500 Market Cap ($ billions)

Market Premium

Intangible Book Value

Tangible Book Value

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This change touches all sectors

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Energy

Materials

Industrials

Consumer Discretionary

Consumer Staples

Health Care

Financials

Telecommunications Services

Information Technology

Utilities

Intangible Value as a % of Total Market Capitalization by Sector

1975

2005

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Here’s the calculation:

• Total corporate value per the stock market

• Minus: tangible assets at historical cost• Minus: intangibles on the balance sheet

from mergers• Equals: “market premium” or

“unrecognized intangibles”

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Tangible, 30%

Intangible, 23%

Goodwill, 47%

Global mergers – 2007(mergers are the one time these intangibles hit the balance sheet)

E&Y: Acquisition Accounting – What’s Next for You?

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The gap is not “goodwill”

• This large amount of intangibles in business is not the result of some abstract market “feeling”

• It is the result of 30+ years of investment in the knowledge infrastructure of American corporations (people, processes, info tech, networks)

• Annual investment in knowledge intangibles now exceeds tangible investment….

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Tangible $1.2 trillion, 43%

Intangible $1.6 trillion, 57%

U.S. corporate investments - 2007

Business Week, October 29, 2009 (using unpublished data from Corrado, Hulten and Sichel)

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What are intangible investments?

Calculations extrapolate from currently-available data including: – Software – R&D– Advertising– Training

�But not everything is counted because current measurement systems (both economic and accounting/financial) were built for a tangible, industrial economy

�And most of these investments are treated (at both macro and firm level) as current-year expenses

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What it all really means

• Analysts and investors cannot rely on the balance sheet to help them value stocks

• So they have to rely on the income statement � but this is a very short-term source of information

• Financialization reflects this short-term view

• Financialization cannot be fixed without also closing the intangibles information gap

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Filling in the gap

• Field of intellectual or intangible capital emerged to study this information gap

• IC field—strong following in Europe & Asia• Focus is primarily on:

– Identifying intangibles– Understanding link to value creation

– Reporting to stakeholders

• Generally identifies three classes of intangibles….

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KnowledgeAssets

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Structural capital is special…

• Paul Romer calls it software • Arnold Kling and Nick Schulz call it recipes• John Zysman calls it the algorithmic

revolution

…Structural Capital is operationalizedknowledge in a highly scalable, enduring

form that is not subject to the laws of scarcity—it changes everything

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The economic opportunity of the knowledge era?

…creating value by leveraging human + relationship

+ structural capital

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To end financialization…

…and take advantage of the potential of the knowledge era, we need to:

– Close the intangibles information gap – Offset the short term view of the income

statement– Give investors and stakeholders a view

previously provided by the balance sheet of the productive capacity and potential of the firm…its intangible capital

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• A manager’s guide to identifying, managing and measuring intangibles

• Goal is to leverage the knowledge and competencies of firms for greater value, performance and innovation

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Resources

Book: www.intangiblecapitalbook.comCommunity: www.icknowledgecenter.comBlog: www.smartercompaniesblog.com

Mary Adams, 781-729-9650adams@i-capitaladvisors.comTwitter: maryadamsica