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There are several arguments on the financial reporting system is incapable of explaining the internally generated intangibles such as relationships and knowledge. Disclosing information on these factors is likely to lower the cost of equity capital because uncertainty about future prospects of a company is decrease and facilitates a more precise valuation of the company. Moreover, some stated that it will also enhance stock market liquidity and increase demand for companies' securities. Information found in companies' annual reports and the information demanded by the market is different.
These differences is due to an increased in demand for non-financial information which concerning the company's strategy, lacks of understanding of business models and communication between company management and the capital market. Externally reporting information on intellectual capital is implemented to prevent any disadvantages on the capital market if information is not reported. This is important for capital markets and external stakeholders to improve their understanding of firm's competitive position. Besides that, it can improve internal communication and internal understanding of the organization.
Challenges that face by firms are identifying their critical intellectual resources and find the correct steps to manage them in order to improve the competitive position of the firm. A better understanding on the organization's intellectual resources and the way to managed it can be achieved through report on intellectual capital. Organizations need to provide more information about what intellectual resources are important and how they are combined to deliver organizational performance. These ensure to provide examples or classifications of intellectual assets which helps organizations to make decision of their intellectual resources.
The reason why traditional balance sheet approaches are unsuccessful is because it failed to provide the information about interconnectivity of assets. The company intellectual capital strategy is about the knowledge resources and their interaction. Firm's knowledge management strategy is clear when the interaction between knowledge resources is understood. Intellectual capital statement divided in to financial and non-financial metrics such as staff turnover, job satisfaction, training and customer satisfaction.
Intellectual statements play an important role in an organization as a management tool used internally in the firm and as a communication tool used to communicate how the firm works to develop its knowledge resources in order to generate value. The statements improves the internal understanding of which resources are important and how it can combined and manage in order to create value. Besides as a reporting tool, it might also as a marketing tool in innovation. Most of the firms think that they publish useful reports but on the readers side it seems they lack of understanding and misunderstood will happen if readers is not clear of the report's content.
The impact of intellectual capital on firms' market value and financial performance (by Maditinos, Chatzoudes, Tsairidis, Theriou)
Intellectual capital is the new wealth of the organizations. This is because the intellectual resources such as knowledge, information and experience are the tools for creating wealth in the organization. Intellectual capital was defined as the intellectual material that can be formalized, captured and leveraged to produce a higher value asset. Method had been developed to measures the efficiency of value added by corporate intellectual ability which known as Value Added Intellectual Coefficient. This method has been used to measure the relationship between the intellectual capital and traditional measure corporate performance.
An empirical investigation had been taken by Chen et al. (2005) from a large sample of Taiwanese listed companies by using value added intellectual coefficient method. From the investigation, it can conclude that investors valuate higher companies with better intellectual capital efficiency and those companies with better intellectual capital efficiency obtain a higher degree of profitability and revenue growth now and in the future.
On the other hand, the empirical data of 96 listed companies from Greek in the Athens Stock Exchange from four different economic sectors were drawn. Results show that there is a statistically significant relationship between human capital efficiency and financial performance. The recent study has been conducted in the banking sector in Greek which gives a positive correlation between value added and physical capital. The results were considered inaccurate because during the investigation there was on a significant upward trend in that period. In relation to this matter, the results could be concluding that it were negatively influenced by the bad economical climate thus failing to underline the importance of intellectual capital.
There are three components in value added intellectual capital which are capital employed efficiency, human capital efficiency and structural capital efficiency. It is hypothesized that the greater the intellectual, the higher the ratio of market to book value. With the three components, investigation can be carry out in an effective way and increase the explanatory power of the conceptual framework. Besides that, studies have found there is a close relationship between intellectual capital and financial performance which the development of structural capital has a positive impact on business performance.
In order to complete the whole task, there were difficulties in finding complete data for the investigation. The sample was limited to 96 companies while the average number of listed company during the investigation year was approximately 280 companies. Some of the data needed for analysis were not able to be retrieved especially the expenses for staff and advertising. In addition, there were only four sectors of economic activity to be investigated and relatively narrow few years of period for data collection to be taken.
It could be preferable if investigation would include with more industries which would yield a more reliable and accurate results supported by the theory. A longer period of sample data would possibly offer different results since longitudinal data will no longer be affected by the early stages of the current financial crisis which affected financial statement of the listed companies in the period under investigation. In a nutshell, different countries and time periods may provide with solid results as to the nature of the relationship between intellectual and financial performance.