The Relationship Between Intangible Assets and Firm

The Relationship between Intangible Assets and on

Firm’s Competitive Advantage and Market Value

1. Introduction

Intangible assets are identifiable as separate assets and may add value to the company. They are non-

financial and non-physical assets which have been created over time and through the investment. The

meet of specific recognition criteria can capitalize the intangible assets. The intangible assets example

are include training, software development, reputation and branding, research and development, the

design of products and services or business process improvements.

The impact of intangible assets has been identified as difficult to be quantified but at the same time

have been recognised as playing an important role in the growth of developed economies.

According to Inaliah et al., 2010 from the research they found that intangible assets can be acquired

by separate purchase, as part of business combination, government grant, exchange of asset, or by

self-creation. The economy's productivity showed growth and they have become more and more

crucial for a firm's survival and prosperity which have been recognized that intangible assets as the

driving force.

Inaliah et al., 2010 find the intangible assets are of increasing importance for the corporate value

creation processes of all kind of organizations. The factors that make the shareholder placing

increasing emphasis on a management’s ability to manage the intangible assets which a proportion of

companies’ value is derived generate from the intangible asset value of commercial significance.

There are being highlighted on the importance of intangibles information is due to components

perceived or actually embedded in the intangibles. These components include items such as R&D,

goodwill, patent, brand-name and other identifiable intangibles (Godfrey &Koh, 2001). The relevance

of intellectual capital which includes typically the human capital, firms’ structural capital and

relational capital has been examined from the aspect of financial and non-financial disclosures

(Iatridis, 2006).

The responsible on the improve of the acquisition valuations such as the classification and useful

economic lives of intangible assets that will helps for intangible asset disclosure is likely to improve

in the future are one of the management importance role towards to the company.

Many researchers they most likely to agree that indicate of the intangible assets also can be

represented by intellectual capital of a company. They intangible capital can be divide into human

capital, structure capital, customer capital, organization capital, innovation capital, and process capital

and focus on the measurements and components of intellectual capital in some specific industry.

2. The Financial Reporting Standards

Intangible Assets and Firm Value

The frequently first step taken in order to measure and manage knowledge of the intangible assets can

be defining by categories the intangible assets which in differentiation of intellectual capital into

human capital, structural capital and some sort of relational capital.

According to Inaliah et al.,2010 The current diversity in definitions and taxonomies of intangible

assets would depend on various perspectives which reflect the diversity of stakeholders. This indicates

that the stakeholders have their own interest in addressing the issue of management, measurement and

reporting intangible assets.

There is evidence from the previous research found by Shih, 2013 on the value relevance of intangible

assets that omission of intangibles from a balance sheet is a serious deficiency, particularly because

value for modern businesses is seen to come more from an intangible asset base than from physical

assets.Proponents of the capitalization of intangibles argue that earnings that reflect the effects of this

capitalization are significantly more highly associated with stock prices and returns.

The first is that traditional accounting rules either understate their value or completely ignore them;

the balance sheets of these companies show little evidence of their value. The second is that a

significant portion of the market values of these firms comes from these intangible assets; there is

evidence, for instance, that brand name alone may explain more than half of the value in many

consumer product companies. Finally, the failure to value these intangible assets distorts both

accounting measures of profitability such as return on equity and capital and market measures of

value.

According to previous studies, the market value of a firm ultimately reflects the value of all its net

assets. In the industrial era, physical assets, such as land, capital, and labor are critical factors to judge

a firm’s value. However, in modern times, the development of communication technology, electronic

commerce, and the internet makes these resources circulate around the world quickly, letting the

knowledge-based economy era evolve (Abu-Musa, 2009).

In addition, the value of the knowledge industry increases rapidly. Organization for Economic Co-

operation and Development in Lu et al., (2010) indicate that knowledge economy is characterized by

possession, distribution, production, and use of knowledge as a critical resource in economics.

Therefore, the important successful factors for companies are the capability and the efficiency in

creation, expansion, and application of knowledge.

The method for creating firm’s value evolved from traditional physical-production-factors to

intangible knowledge. In this situation, a large part of a firm's value may be reflected by its intangible

assets. Evaluating firm’s value involves not just the tangible assets, but also the power of intangible

assets (i.e. the difference between the market value and book value of a company) (Chan et al., 2001;

Eckstein, 2004).

There is therefore potentially a significantly higher incidence of earnings management and financial

misstatement. Hence, the impact of the capitalization of intangibles on the valuation of firms and

quality of accounting is unclear. Our objective in this study is to provide direct evidence intended to

aid in resolving this problem by analysing how the value of intangibles affects the relationship be-

tween the market value of a firm and its book value.

Shin, 2013 find that in research of Feltham and Ohlsonused a given relation between operating and

financial assets for evaluating firm value (hereafter the FO model) in which the relative weights

between a firm’s operating and financial assets on equity will affect future distributions of earnings,

and thus affect the valuation of a firm. A change in intangible assets not only affects the relative

weights between operating andfinancial assets, but also affects the quality of accounting information

and the value of a firm. However, this given relation is time dependent and will change as time passes.

Consistent with theory, we find that intangible assets influence the weight of operating assets on book

value of equity.The more intangible as- sets a firm has, the more operating assets it will have, and the

higher value of the firm will be.Shin, 2013 mention that focusing on exploring the impact of

intangible assets on market value of firms and quality of accounting information, this paper can

provide theoretical support toaccounting reform in regard to value relevance for standard setters.

Inaliah et al.,2010 said these literatures do provide some indication thus it can be summarised that

previous research shows that many ways of corporate communication of intangible assets to users,

different scopes of intangibles reporting regarding industry, countries and longitudinal studies, many

intangibles reporting being voluntary rather than mandatory, there are relationship between intangible

asset capitalisation and firms ‘market values and finally intangible asset disclosure lead to increase in

stock price and market capitalisation

Theoretical Framework

This research attempts to know whether the intangible assets affect firm’s competitive advantage and

market value. It is also designed to find out whether the industrial types have some role on the impact.

The dependent variables in this research are firm’s competitive advantage and market value. The

independent variable is the intangible assets owned by the company. Industrial type acts as the

moderating variable. The researchers wanted to know whether the intangible assets owned by firms

has significant impact on stock return, and especially in what kind of industry. Figure 1 shows us the

conceptual framework of this research.

Formulation of Hypothesis

Firm’s Competitive Advantage

Resource-based theory suggests intangible resources as the main drivers of the sustainability of

performance differences across firms (Villalonga, 2004). Different contributors to the resource-based

theory literature have used different terms, such as capabilities, core competences, or knowledge, to

refer to these resources and a variety of definitions has been offered. This research will use intangible

assets.

Ghemawat (1991) proposes a specific vehicle through which the characteristics of intangible asset

translate into sustainability of competitive advantages for firms. In his view, intangible assets, because

of their lower tradability and higher stickiness, are particularly prone to be a source of commitment,

which he defines as the tendency of strategies to persist over time. Commitment, in turn, is “the only

general explanation for sustained differences in the performance of organizations”.

Villalonga (2004) shows that asset intangibility is positively related to the persistence of firm-specific

profits or losses. The results support the interpretation that intangible assets play an important role in

sustaining a firm’s competitive advantage, as predicted by the resource-based theory. On the other

hand, they also suggest that intangible assets also have similar role in sustaining a firm’s competitive

disadvantage. Intangibles appear to be a double-edged sword, as a result of their greater stickiness

relative to tangible resources. Ghemawat (1991) found out intangibles-based commitment is driving

sustained performance differences. The double-edged effect is a key implication of the resource-based

theory, and the finding provides further empirical support for this theory.

H1: The greater the degree of intangible assets, the greater the degree of firm’s competitive advantage

Firm’s Market Value

In signaling theory (Dragota and Semenescu, 2008), managers know the true distribution of firm

returns while investors do not. Managers benefit if the firm’s securities are more highly valued by the

market but are penalized if the firm goes bankrupt. Under such circumstances, the level of debt

managers chose, serves as a signal on the quality of the company, a signal sent from the managers as

possessors of private insider information towards outside investors. Myers and Majluf (1984)

assumed perfect financial markets, except that investors do not know the true value of either the

existing assets or the new opportunity. Therefore, investors could not precisely value the securities

issued to finance the new investment. The two authors assume that managers act in the interest of

existing shareholders and refuse to issue undervalued shares unless the transfer from “old” to new

stockholders is more than offset by the net present value of the growth opportunity.

Companies with more intangible asset are characterized by high information asymmetry (Alves and

Martins, 2010). Their managers have incentives to disclose their superior information to capital

markets. Therefore, the market value of companies will depend on how the managers signal the

market. Companies which are signaling higher intangible asset will have positive response from the

market.

The present study investigates the relationship between intangible assets and firm’s market value. It is

important to note that advanced markets such as the US and the UK have reported an increasing role

of intangible assets (specifically goodwill) in determining the market value of a firm (Lev and Daum,

2004). Following this fact, the second hypothesis is formulated:

H2: The greater the degree of intangible assets, the greater the firm’s market value

Industrial Type

The impact of intangible asset on the sustainability of performance differences across firms is likely to

vary systematically by industry, for two reasons. First, the intangible asset that can be a source of

advantage are likely to be of a different nature in different industries and sectors (Villalonga, 2004).

Technological knowledge base built through research and development is more likely to be a source

of competitive advantage in the manufacturing sector than it is in the lodging and entertainment

industries. Amit and Schoemaker (1993) use the term “strategic industry factors” to refer to the set of

resources that has become the prime determinant of economic rents for industry incumbents. They

note that the capacity of a firm’s resources for creating and protecting the firm’s competitive

advantage depends not just on their unique characteristics but also on the extent to which they overlap

with industry-determined strategic industry factors.

Second, the efficacy of different mechanisms for ensuring the appropriation by firms of the value

generated by intangible resources is also likely to vary across industries (Villalonga, 2004). Levin et

al. (1989) provide evidence that the efficacy of different mechanisms for ensuring the appropriation

by firms of returns to R&D varies significantly across industries. Following this fact, this differences

level of intangible asset across industries will give different impact to the sustainability of firm’s

competitive advantage. Barnes (2010) has found that investment in total intangibles is generally more

intensive in manufacturing than services. These service industries include finance and insurance,

construction, telecommunication, wholesale and retail sales companies similar with the industrial

classification in Indonesia. Therefore the third hypothesis is formulated:

H3: The impact of intangible assets to firm’s competitive advantage will be more intensive in

manufacturing company than in non manufacturing company

Recent articles in Japan, Netherlands, United Kingdom, and Canada suggests that intangibles are

likely to be relatively more important in some industries than others (Barnes, 2010). And the type of

intangible investment also varies across industries. These studies have found that investment in total

intangibles is generally more intensive in manufacturing than services. This might be expected, given

the concentration of scientific R&D in manufacturing, but the extent of the difference between

manufacturing and services varies considerably across countries. Less expected is the result in some

countries, organisational capital (strategic planning, adaptation and reorganisation) which is often

seen as being related to investment in IT, is also more intensive in manufacturing than in services.

These differences of intangible intensity will develop different market value across industries.

Therefore, the last hypothesis would be:

H4: The impact of intangible assets to the firm market value will be more intensive in manufacturing

company than in non manufacturing company.

Following byShin,2013 we assume that a principle, which is the firm’s owner and also a manager, has

the ability of forecasting his/her firm’s future cash flows. Under the going-concern assumption, the

owner-manager of the firm will receive cash dividends and cause an increase in utility in each period.

Therefore, the problem is to choose a sequence of dividends that will maximize the present value of

the utility.

Feltham and Ohlson (1995) built a model that connects a firm’s market value and the accounting data

related to operational and financial activities. A firm’s book value of equity is considered to be equal

to the sum of book value of operating assets (oa) and financial assets (fa)1. In the FO model, financial

assets can only have normal returns. Abnormal earnings are generated only from the operating assets

of a firm. Since conservative accounting induces bias, it will reduce the book value of operating

assets. Under unbiased accounting, the book value of a firm is equal to its market value. Conservative

account-ing systematically understates the value of operating as-sets so that book value of the firm is

lower than its mar-ket value. Consistent with Feltham and Ohlson (1995), we assume that the

accounting measurements satisfy the clean surplus relation.

According to previous studies, The decision usefulness paradigm suggests that accounting

information is useful if utilized by financial statements users for or significantly associated with their

decision making (Riahi-Belkaoui, 2000).The main users are those who make decisions having an

impact on firms’ value, specifically decision making by capital market participants (Beaver, 2002;

Riahi-Belkaoui, 2000). According to the information content concept in decision usefulness paradigm,

accounting information is useful based on explanation on issues from the signalling theory. The

signals from accounting information including intangible assets associate the information concerning

the value relevance concept in an efficient market hypothesis.

Observation and analysis

Research Result Description

The descriptive analysis conducted to determine the characteristics of the data in the form of average

and Standard deviation. Here is the result of data description for variables in the study. The results of

descriptive analysis for each research variable can be seen on Table 3.

Regression Analysis

Before doing multiple regressions, classical assumption tests are conducted. The result of classical

assumptions test in detail is shown in Table 4. While the regressions result of the impact of intangible

assets on the dependent variables is shown in tables that follows. Its impact on firm’s competitive

advantage is shown in Table 5, on firm’s market value in Table 6, on firm’s competitive advantage

and market value using industrial type as the moderating variable in Table 7 and 8.

Discussion of Results

The Impact of Intangible Asset to the Competitive Advantage

The first hypothesis stated that the greater the degree of intangible assets, the greater the firm’s

competitive advantage. Intangible assets play an important role in sustaining a firm’s competitive

advantage, as predicted by the resource-based theory. Based on Table 5, the significance value of IA

is less than 0.01. As the result, we accept the first hypothesis at significance of level 1%. It depicts

that intangible assets have a significant effect to the firm specific profit which is the proxy of firm’s

competitive advantage. Specifically, they have positive relation with firm’s competitive advantage.

So, our first hypothesis is accepted which means the greater the degree of intangible assets owned by

a firm; the greater the degree of its competitive advantage.

The result of this research is consistent with Villalonga (2004) who shows that resource intangibility

is positively related to the persistence of firm-specific profits or losses. Ghemawat (1992) stated that

intangible assets, because of their lower tradability and higher stickiness, are particularly prone to be a

source of commitment, which he defines as the tendency of strategies to persist over time.

Commitment, in turn, is the only general explanation for sustained differences in the performance of

organizations.

The Impact of Intangible Assets to Firm’s Market Value

The second hypothesis stated that the greater the degree of intangible assets, the greater the firm’s

market value. In signaling theory (Dragota and Semenescu, 2008), managers know the true

distribution of firm returns while investors do not. Managers benefit if the firm’s securities are more

highly valued by the market but are penalized if the firm goes bankrupt. Companies with more

intangible asset are characterized by high information asymmetry (Alves and Martins, 2010).

Therefore, firm’s market value of companies will depend on how the managers give signal to the

market. Companies who signal they have higher intangible asset, would received a positive response

from the market.

Based on Table 6, the significance value of IA is less than 0.01. As the result, we accept the second

hypothesis at significance of level 1%. It depicts that intangible assets have a significant effect to

firm’s market value. Specifically, they have a positiverelation with firm’s market value. So, our

second hypothesis is accepted which means that the greater the degree of intangible assets owned by

firms, the greater the market value. The result of this research is consistent with Salamudin et al.

(2010) who found that Malaysian market has begun developing intangible assets and recognising the

importance of intangible assets in the recent years.

The Impact of Intangible Asset to the Competitive Advantage in Different Industrial Type

The third hypothesis stated that the impact of intangible assets to the firm’s competitive advantage

will be more intensive in manufacturing company than in non manufacturing company. Intangible

asset is the key of firm’s competitive advantage. Therefore, intangible assets play an important role in

sustaining a firm’s competitive advantage, as predicted by the resource-based theory. However,

different type of industry will give different level of effect. Based on Table 7, the significance value

of interaction model of IA and TP is less than 0.05. As a conclusion, we accept the third hypothesis at

significance of level 5%. It depicts that the impact of intangible asset to firm’s competitive advantage

will be more intensive in manufacturing company than in non manufacturing company. Specifically,

this moderating interaction has positive relation with the firm’s competitive advantage. So, our third

hypothesis is accepted which means that the impact of intangible assets to firm’s competitive

advantage will be more intensive in manufacturing company than in non manufacturing company.

Based on Table 7, the significance value of TP is lower than 0.1. As the result, we accept that industry

level have a significant effect to the firm’s market value at the significance level of 10%. Therefore,

industry type in this research is role as quasi moderating variable.

The Impact of Intangible Asset to the Firm Market Value in Different Industry Type

The fourth hypothesis stated that the impact of intangible assets to firm’s market value will be more

intensive in manufacturing company than in non manufacturing company. In signaling theory

companies who signals they have higher intangible asset, would receive a positive response from the

market. However, different type of industry will have different type of effect.

Based on Table 8, the significance value of interaction model of IA and TP is less than 0.05. As a

conclusion, we accept the fourth hypothesis at significance of level 5%. It depicts that the impact of

intangible asset to firm’s market value will be more intensive in manufacturing company than in non

manufacturing company. Specifically, this moderating interaction has positive relation with the

market value. So, our last hypothesis is accepted which means that the impact of intangible assets to

firm’s market value will be more intensive in manufacturing company than in non manufacturing

company.

Based on Table 8, the significance value of TP is lower than 0.1. As the result, we accept that industry

level have effect to the firm market value at the significance level of 10%. Therefore, industry type in

this research is role as quasi moderating variable

Conclusion

Based on the discussion of results in previous section, it can be concluded intangible assets have a

positive effect to firm’s competitive advantage. Firm with higher intangible asset will have higher

competitive advantage. The source of firm’s competitive advantage over its competitor comes from its

core competencies. Core competencies are capabilities that serve as a source of competitive advantage

for a firm over its rival. Intangible assets are the core competencies of the companies. Intangible

assets have positive effect to the firm market value. Companies with more intangible assets are

characterized by high information asymmetry. Their managers have incentives to disclose their

superior information to capital markets. Therefore, their market value of companies will depend on

how the managers signal the market. Companies which signal higher intangible asset would receive

positive response from the market. These effects are more intense manufacturing company than in non

manufacturing company. The capacity of a firm’s resources for creating and protecting the firm’s

competitive advantage depends not just on their unique characteristics but also on the extent to which

they overlap with industry-determined strategic industry factors. Given the scientific R&D in

manufacturing company, the effect of intangible assets to the competitive advantage will be more

intense.

From the studies we found that intangible assets are increasingly recognised as essential for

sustainable corporatecompetitive advantage. This study provides empirical evidence that investors

placehigher value with higher intangible assets. Current accounting standards restrain mostintangibles

such as brand and other intellectual capital elements from being recognisedin the financial statements.

The task of accountants is to improve the credibility andreliability of soft asset valuations or to find

other creative solutions to the problem, andnot to simply ignore this fast growing segment of the

economy, thus losing sight of theoverall objective of financial reporting, which is to provide

information that is useful(Wallman, 1996).

Our results suggest that the relation between intangible assets and operating as-sets is positive. As a

firm’s intangible assets increase, the relative return rate for operating assets to that for financial assets

will also be enhanced. Therefore, a firm will increase its investment in operating assets. In addition, as

a firm’s intangible assets and operating assets increase, it will distribute cash dividends in the future

and thus raise firm value.

This implies that the more intangible assets a firm has, the higher the firm value will be. However, the

book value of intangible asset understates its real value due to accounting conservatism and thus

deteriorates the value-relevance of accounting information. This result provides analytical support for

prior empirical research (e.g. Collins, et al. 1997; Lev and Zarowin [12]; Wyatt, 2005). These findings

can also help investors to evaluate firm value based on an accounting-based valuation model under

changing economic conditions.

In the concluding remarks, as indicated in this study’s findings, the role ofintangibles or intellectual

capital are gaining more importance as perceived by themarket and this has potentially significant

implications for the focus of future researchand regulatory developments in the intangible reporting

practices.