INTANGIBLE ASSETS Measurement, Drivers, Usefulness

Working paper #2003-05 By

Feng Gu and Baruch Lev^*

Boston University School of Management

Accounting

595 Commonwealth Avenue

Boston, MA 02215

gu@bu.edu

Phone: (617) 353-4985

Fax: (617) 353-6667

^* The authors are at Boston University and New York University, respectively. We are grateful to participants at the 4^th Intangibles Conference and the 2002 American Accounting Association annual meeting and workshop participants at Osaka University for their helpful suggestions and comments. Feng Gu acknowledges the financial support provided by Boston University, School of Management. Baruch Lev retains exclusive rights to the measures described in this paper, and has a patent pending for them. The measures should not be used or reproduced without a written permission from the author.

Abstract

The measurement and valuation of intangible assets are a matter of considerable interest to managers, investors, and accounting-standard setters. Important decisions concerning intangibles are hampered by the lack of systematic and comparable measures for these increasingly important assets. In this study, we provide an approach to estimating the value of intangible assets that are not recorded on the firm’s balance sheet. The methodology is based on the economic notion of “production function,” where the firm’s economic performance is stipulated to be generated by physical, financial, and intangible assets. We estimate the contribution of intangible assets by subtracting the normal returns on physical and financial assets from an earnings-based economic performance measure. Capitalizing the expected value of this contribution over future years yields an estimate of intangible capital.

We find compelling evidence that our approach provides economically meaningful estimates of intangible assets. Our results indicate that investments in R&D, advertising, brands, information technology, and human resource practices are important drivers of intangible capital, and in turn corporate value. We find that intangibles measures provide more value-relevant information than conventional performance measures, such as earnings and cash flows. Furthermore, the approach is shown to be useful to investors seeking information on future performance of valuable intangibles. We document extensive evidence that the intangibles-based measures can effectively distinguish between overvalued and undervalued stocks.

We believe the intangibles measures described here can add an essential, and hitherto missing, valuation tool for managers and investors concerned with intangible assets. The results on the value drivers of intangible can also be potentially useful to regulators in identifying candidate disclosure items to be considered in their effort to improve disclosure on intangibles.

Keywords:                 Intangibles, measurement, drivers, usefulness.

Data Availability:     Data are available from sources identified in the text.

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