Intellectual Capital

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INTELLECTUAL CAPITAL

The term intellectual capital defines a range of intangible assets that a company possesses alongside its physical and financial assets but which can't be quantified in the same manner. Among these are the intellectual property and patents claimed by the firm; its employees' and managers' collective knowledge about their products and services and about the way the firm and its market function; and the internal information infrastructure, systems, and software that enable the dissemination, sharing, manipulation, and optimization of that knowledge. The Organization for Economic Cooperation and Development (OECD) defines intellectual capital simply as "the economic value of two categories of intangible assets of a company: (a) organizational (structural) capital; and (b) human capital." Structural capital, according to Financial Management, covers supply chains, distribution networks, and proprietary software systems. While these features of businesses are not native to the New Economy, the importance they have assumed in the Information Age, in terms of the workings of the firm and its perceived value, is altogether unprecedented and rapidly escalating.

In part, the concept of intellectual capital grew out of a growing dissatisfaction among many academics, accountants, and—perhaps especially—investors with standard accounting methods, which did a poor job of assessing the actual value of firms, particularly firms operating in or around the fields of information technology (IT) or other knowledge-intensive sectors. In order to accurately assess the value and prospects of such firms, these critics contended, it was necessary to somehow quantify and account for the collective knowledge and the organization of that knowledge within a firm.

The major factors contributing to the growth and importance of intellectual capital were economic globalization, which greatly intensified global competition and trade; the trend, especially in the United States but in much of the rest of the world as well, toward the deregulation of markets, particularly in such IT-heavy sectors as telecommunications that had previously largely worked outside of the competitive market system; and, of course, the tremendous technological innovation in knowledge-related fields, particularly the growth in IT and computers, which placed information at the center of firms' operations. All these changes forced a shift in corporate organization toward a less centralized and vertical model of corporate organization, greater outsourcing of operations, and more fluid channels of interaction within and between firms, all of which enhanced the importance of intellectual capital.

FIRMS TAKE STOCK OF THEIR INTELLECTUAL CAPITAL

Intellectual capital was a lively topic in the business literature of the early 1990s, but the idea fizzled, according to Information Today, largely on the inability of researchers to devise a satisfactory method of measuring it. Without an adequate means of quantification, the idea essentially had no way of being practically integrated into accounting methods. As a result, the issue faded into the background for several years before reemerging in the late 1990s when the Internetand information technology proved among the primary engines of the fantastic boom in the U.S. economy. While quantification techniques continued to be debated and compared, intellectual capital, an increasingly recognized asset, became a field ripe for management concerns, as companies, determined to maintain their competitiveness in an information-centered economy, required an accurate assessment of the intellectual value harbored in their ranks.

To organize and capitalize on intellectual capital, an entire field of knowledge management was born, including theoretical techniques and extensive and sophisticated knowledge management software programs that companies increasingly integrated into their infrastructure to facilitate the transfer, support, and optimal use of knowledge within the firm.

As intellectual capital grew increasingly central to a firm's operations and value, managers were compelled to take ever-greater steps to protect their intellectual capital from compromise. The task of keeping knowledge, including knowledge inside employees' heads, within the purview of the firm at all times was a growing concern in the 1990s and early 2000s. One mark of this trend was the increasing number of confidentiality agreements devised by companies for their employees to sign, thereby guaranteeing that while they work at the firm and even after they leave, they will not divulge information and company secrets to other parties.

Quantification of intellectual capital involves consistent performance measurements and knowledge assessments that must then be publicized in a manner that investors and accountants can recognize. One leading authority on intellectual capital, New York University's Leonard N. Stern School of Business Professor Baruch Lev, defined intellectual capital in terms of an asset: a claim to a benefit a company expects to reap in the future but which, unlike a piece of machinery or commercial property, doesn't have a physical or financial embodiment. Intellectual property, such as patents or copyrights, is thus one branch of intellectual capital, the one that was in fact legally recognized and secured. The fact that the field of patenting has expanded to include not only physical inventions but also business processes and practices also greatly boosted the centrality of intellectual capital.

ASSESSING VALUE IN THE INFORMATION AGE

According to Computer World, the growing difference between a company's book value share price and its market value share price is often, and increasingly, chalked up to intellectual capital. As Arthur Levitt, former chairman of the Securities and Exchange Commission (SEC) told the Economic Club of New York, "As intangible assets grow in size and scope, more and more people are questioning whether the true value—and the drivers of that value—are being reflected in a timely manner in publicly available disclosure."

Indeed, Fortune reported the results of a long-term study by Arthur Andersen consultants Richard Burton, Barry Libert, and Steve Samek, who for two decades monitored the gap between the book value and the market value of 3,500 U.S. companies. The results strongly favor those who insist that intellectual capital is being unduly, and potentially dangerously, ignored. In 1978, according to the study, book value for all the companies averaged 95 percent of market value. By the end of the 1990s, book value amounted to just 28 percent of market value. While the precipitous decline in technology stocks and the attendant slowing of the U.S. economy in the early 2000s showed some of this discrepancy to be the result of a stock-market bubble, analysts were in general agreement that no small amount of the difference could indeed be chalked up to unquantified intellectual capital. In other words, investors increasingly saw value in companies that traditional accounting methods were simply incapable of quantifying. Federal Reserve Board Chairman Alan Greenspan warned that such a gap between hard accounting data and the perceptions and confidence of investors was bound to breed tremendous problems in the future if left uncorrected.