ANTHONY MWANGI NJOROGE D63/75818/2012

Transcription

1 THE EFFECT OF INTELLECTUAL CAPITAL ON MARKET VALUATION FOR FIRMS LISTED IN THE NAIROBI SECURITIES EXCHANGE BY ANTHONY MWANGI NJOROGE D63/75818/2012 A RESEARCH PROJECT REPORT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF THE DEGREE OF MASTER OF SCIENCE FINANCE, UNIVERSITY OCTOBER, 2013

2 DECLARATION This research project is my original work and has not been presented for an award in any other university or college. Signature: Date: 20 ANTHONY MWANGI NJOROGE D63/75818/2012 This research project has been presented for examination with my approval as research project Supervisor;- Signature: Date: 20 DR JOSIAH ADUDA Chairman- Department of finance and accounting School of Business University Of Nairobi ii

3 DEDICATION To my family, friends and lecturers, may this work be a living proof that hard work, patience, persistence, and prayers can make you actualize your dreams. iii

4 ACKNOWLEDGEMENT I register my profound gratitude and sincere acknowledgements to my informants, my fellow students who assisted me in diverse capabilities. I also express my indebtedness and special gratitude to Dr. Aduda, my supervisor, who assisted me in undertaking this research, for his guidance without which, this research would not have been possible. His scholarly comments, academic challenges and constructive dialogue were an invaluable inspiration in the completion and quality of this project. My deep appreciation goes to the people who in one way or another, made it possible for me to start and complete this research project. In the bibliography, I duly acknowledge with gratitude the authors of the data used. iv

5 ABSTRACT Intellectual capital can be viewed as a resource of knowledge available on the company that produces high-value assets and economic benefits in the future for the company. There has been a lot of interest on intellectual capital at both theoretical and empirical levels. Theorists have identified three components of intellectual capital, namely: human capital, structural capital and customer capital. There has been consensus from empirical review of previous studies that intellectual capital has positive impact on productivity and profitability of a firm. However, there has been conflicting findings and conclusions thereon on the effect of intellectual capital on the market value of a firm. This study sought to establish the effect of intellectual capital, both as an aggregate and as disintegrated into its three components, on the market value of firms listed in the Nairobi Securities Exchange (NSE) Data was obtained from 34 firms that had been listed in the NSE from 2003 to 2012 and those that had their financial year ending on 31 st December. Pulic, (2000) Value Added Intellectual Coefficient model (VAICTM) was adopted as to measure the intellectual capital indicator. Multiple linear regressions and correlation analysis were applied to analyse the data. The major findings from the analysis of the data collected were that there is a positive relationship between intellectual capital as a whole and in individual components on the market value of firms listed in the NSE. It was thus concluded that intellectual capital has a positive effect on the market value. From the findings and conclusion thereon, it is recommended that there should increase in investment in intellectual capital. Firms should focus on enhancing the capacity of their human capital which was found to have the highest effect on the market value. They should enhance their structural capital by ensuring that they have proper systems and procedures by which to track their actions. Customer capital should also be enhanced by endeavouring to satisfy customer needs. This study suggests a further research on the effect of intellectual capital on growth of firms listed in the NSE and Kenyan economy. v

6 TABLE OF CONTENTS DECLARATION... ii DEDICATION... iii ACKNOWLEDGEMENT... iv ABSTRACT...v TABLE OF CONTENTS... vi LIST OF TABLES... ix LIST OF ABBREVIATIONS...x CHAPTER ONE...1 INTRODUCTION Background of the study Intellectual Capital Company s Market Value Intellectual Capital and Capital Market Value Nairobi Securities Exchange Research Problem Research Objectives Value of the Study...5 CHAPTER TWO...6 LITERATURE REVIEW Introduction Theoretical review Economic Perspectives Strategic Perspectives Managerial Perspectives Accounting Perspectives Empirical Review Intellectual Capital Human Capital Structural Capital Customer Capital Measurement of Intellectual Capital Market Valuation vi

7 2.6 Summary of Literature Review CHAPTER THREE RESEARCH METHODOLOGY Introduction Research Design Population Sample Design Data Collection Data Analysis CHAPTER FOUR: DATA ANALYSIS AND PRESENTATION OF FINDINGS Introduction Data Presentation... Error! Bookmark not defined Regression Analysis for Year Regression Analysis for Year Regression Analysis for Year Regression Analysis of Year Regression Analysis for Year Regression Analysis for Year Regression analysis for Year Regression analysis for Year Regression analysis for Year Regression Analysis Summary and Interpretation of Findings CHAPTER FIVE SUMMARY, CONCLUSION AND LIMITATIONS Summary of Findings Conclusions Policy Recommendations Limitations of the Study Areas For Further research REFERENCES vii

8 APPENDICES Appendix 1: Companies listed in NSE Appendix II: Data viii

9 LIST OF TABLES Table 4.1: Model Summary Table 1: Coefficients Table 4.2: Model Summary Table 2: Coefficients Table 4.3: Model Summary Table 3: Coefficients Table 4.4: Model Summary Table 4: Coefficients Table 4.5: Model Summary Table 5: Coefficients Table 4.6: Model Summary Table 6: Coefficients Table 4.7: Model Summary Table 7 : Coefficients Table 4.8: Model Summary Table 8: Coefficients Table 4.9: Model Summary Table 9: Coefficients Table 10: Model Summary Table 10: Coefficients ix

10 CEE DIV DP HCE I IC IP ISE LAPSSET NSE R PRISM LIST OF ABBREVIATIONS Capital Employed Efficiency Dividends Depreciation Human Capital Efficiency Interest expenses Intellectual Capital Intellectual property Istanbul Stock Exchange Lamu Port, South Sudan, Ethiopia Transport corridor Nairobi Securities Exchange Retained earnings Policy-making, Reporting and measuring, Intangibles, Skills development and Management SCE T TSE VAIC TM VA W Structural Capital Efficiency Tax Taiwan Securities Exchange Value Added Intellectual Coefficient Model Value Added Salaries and wages x

11 CHAPTER ONE INTRODUCTION 1.1 Background of the study In the business context, capital is viewed as any financial resource available for use in the creation of wealth and in most cases it is tangible in nature. For any listed company the value of such capital is publicly disclosed to the investors in their financial statements whether quarterly, half yearly or in the end year financials. The capital can be divided into two categories; financial and physical. The most common form of financial capital comprises of shareholders equity, retained earnings and any other reserves. The physical capital refers to the property plant and equipment in the books of the company Intellectual Capital According to Stewart (1997), the intellectual capital is intellectual material that has been formalized, captured and leveraged to create wealth by producing a higher value asset. On this definition of intellectual capital is a resource of knowledge available on the company that produces high-value assets and economic benefits in the future for the company. Intellectual capital is here integrated between technology and information that support the company's relationships with outside parties. In line with the above definition of intellectual capital, cited Brinker (2000) equate intellectual capital as the sum of human capital and structural capital (eg relationships with consumers, network management and information technology) Bontis et al (2000) also explains that the whole process intellectual capital and assets that usually do not appear on the balance-sheet and all intangible assets (trademarks, patents, and brands) which is the contribution of human knowledge in the category of corporate resources. Intellectual capital can also be briefly described as an organizational capability to create, 1

12 perform and implement knowledge transfer. Borrowing from these notions, intellectual capital is a company s resource that is not physical but can generate an added value to increase the company's market value Company s Market Value Company's market value is useful to provide information about the company's performance in the past and its prospects in the future. The market value can be measured using the ratio of market value (market value ratio). According to Gitman (2009) Market ratio is relate a firm's market value, as measured by its current share price, to certain accounting value. Ratio used to measure a company's market value in this study is the market-to-book ratio. This ratio provides assessment of how investors view the company's performance and expect a high return in accordance with the risks Gitman(2009) Intellectual Capital and Capital Market Value Intellectual capital is believed to give an important contribution in increasing the market value and financial performance of a company, Ulum et al, (2009). In an efficient market investors will give a higher value and increase their investment in companies that have investments or greater spending on intellectual capital Belkaoui (2003). Investors believe that intellectual capital is a major factor needed by companies amid fierce competition, which will then provide an increase in market value and financial performance Nairobi Securities Exchange There has been a huge disparity between the companies market value and book value of NSE listed companies prompting the question how one can determine the value of the intangible assets. Some listed companies quote their intangible assets as goodwill in their financial statements. Most companies in the NSE especially those in the service industry e.g. 2

13 banks and telecommunication companies have in the recent past been investing heavily on intellectual capital. Various empirical studies show that the NSE is efficient at least in the weak efficient. However, cases of over and under valuation by the capital market has consistently. At times, companies with significant investment in intellectual capital have continuously traded below the intial public offer price e.g. Safaricom 1.2 Research Problem The worldwide community is being progressively shrunk by technology. Richardson, (1991). Particularly, the turn of 21 st Century has seen an entry of knowledge driven economies with the shift being from production age to knowledge age and from production based labour to knowledge driven workers. The two major forces that Kenyan businesses currently face include the rapid rate of technological change and increasing industrialization. The rate of change is likely to accelerate in the near future led by developments in the country s Vision 2030 development projects. The Vision 2030 flagship projects e.g. the Konza city which is destined to become Kenya s Silicon Valley and the LAPSSET project will definitely give way to new industries. Unfortunately, most Kenyan businesses are still for the most part using traditional financial accounting and performance measurement methods which were developed centuries ago for an environment of arm s-length transactions using primarily tangible assets such as buildings and equipment. The knowledge-based business environment that Kenya and most other countries are currently developing requires a new model and nomenclature that encompasses intangible assets. In this case, the intellectual capital (IC) model is receiving increased interest. 3

14 Firer and Stainbank (2003) tested the relationship between IC and firm s performance in South Africa. They find out that IC has positively correlated with profitability and productivity, but it doesn t have relation to market valuation. Kamath (2008) tried to examine IC and firm s performance in the Indian pharmaceutical industry. The study results indicate that human capital has a prominent influence on profitability and productivity, but it does not have relation to market valuation. However, using data from 30 randomly selected companies from the (UK) FTSE 250 from 1992 to 1998, Pulic (2000b) showed that the average values of VAIC and firms market value exhibit a high degree of correspondence. Ming Chin et al (2005). Further an investigation of the relationship between IC and market value of firm by Ming Chin et al (2005) using data from firms listed in the Taiwan Stock Exchange (TSE) during showed a positive relationship between IC and the market value. It appears that there is no agreement on the impact of intellectual capital on the market value of a firm. Further there are too few studies done in the Kenyan market regarding intellectual capital. Much worse, none of them to the best of my knowledge, examines and gives a conclusive result, hence the need to carry out the research. This study differs from the rest in that is relates to the Kenyan scenario. The study seeks to establish the relationship between IC and the market value of a firm with reference to firms listed in the Nairobi Securities Exchange. 1.3 Research Objectives i. To establish the effect of intellectual capital on the market value of a firm. ii. To establish the effect of individual components of intellectual, that is, human capital, structural capital efficiency and capital employed on the market value of a firm. 4

15 1.4 Value of the Study The results of the study will provide additional evidence to the literature about the relationship between IC and company s performance in the emerging economies. Managers and owners of firms in Kenya will get an insight value of intellectual capital components to their firms. The government appreciates that regulation is an important aspect of the economy especially in boosting investor confidence. For this reason the results of this study will be used by the government in formulating policies and guideline on minimum wage that will suit the Kenyan economy. Furthermore with this results in mind the government can develop and education curriculum that produces competitive graduates into the job market and therefore drive the economy on knowledge and reduce brain drain. 5

16 CHAPTER TWO LITERATURE REVIEW 2.1 Introduction This chapter discusses various literatures, both theoretical and empirical regarding intellectual capital and market valuation. It will adopt the following structure: theoretic review, empirical review, intellectual capital and market valuation. 2.2 Theoretical review There has been extensive work done on IC after it was first discussed by John Kenneth Galbraith in Theories on IC can be analysed from different perspectives as follows: Economic Perspectives According to Marr (2007), economists are prevalently among the authors who first talked about intellectual capital, viewing it as an additional key production factor to be used in the process of the business. During the Industrial Revolution the economy changed fundamentally as countries rapidly developed. The number of businesses increased and greater production ensued, among other reasons, because of the introduction of the division of labour and the continued expansion of the market. At that time businesses were based on tangible assets, such as land, buildings and machinery, which were combined with manual labour to create value. Two centuries later, the New Economy has emerged with a massively expanded service sector, in which tangible assets are no longer so important; the capital-intensive industries that replaced those previously heavily reliant on labour have in turn been replaced by knowledge-based industries and the more educated labour forces required to staff them. Traditional financial measures fail to assess the performance of those businesses increasingly 6

17 reliant on intangible resources OECD, (1999) Businesses operating in every sector have to compete for excellence; not only those that have intangible products, but businesses producing the physical products that are used to supply them Martínez Ochoa, (1997). Firms need to understand what makes them competitive, because there has been an unnoticed change in the way wealth is created over the last years PRISM, (2003) Strategic Perspectives Strategy permeates the entire organisation, identifying the path that all the firm s departments and functions have to pursue in order to accomplish the objective of creating value. Intellectual capital resources are often performance drivers; hence, there is a causal relationship between those resources and value creation. They require to be interrelated to create more value (Marr, 2005). Intangibles have now become of higher importance, both in value terms and in contribution to growth, than tangible assets Lev (2003). As Brooking (1997) observes, the value of many enterprises no longer resides in their tangible assets, but in their intangibles. The success of a company s strategy is critically dependent on those assets, but the accumulation or depreciation of intellectual capital is also determined by strategy. Therefore, a two-way relationship exists between resources and strategy. When the objectives and the direction the enterprise is going to take are being formulated, it is necessary to take into account the stocks of intangibles within the organisation, and to determine the best way in which they can be deployed to achieve more competitive advantage, as well as how they could be increased and developed, so the enterprise has more resources to work with. In a successful know-how company, there must be professional staff at the core of the business that differentiates the company from its rivals; in addition, there must also be 7

18 effective managers who organise the firm and, in this way, increase the company s value. Intellectual capital is therefore more closely associated with value creation (management perspective), rather than with valuation (financial perspective). Consequently, many authors are more interested in visualizing, controlling and managing value creation, than in valuing the assets themselves Managerial Perspectives Following Edvinsson (1997), Lynn (1998) and Marr (2005) observe that organisations employ three types of capital: physical; financial; and intellectual capital. These capitals combine to form an organisation s resources, and as such need to be well managed. Edvinsson and Malone (1997) explain that intellectual capital increasingly provides the roots of a company s value, being the invisible factors that contribute to create it in the firm, over and above the stock of visible or tangible assets. Brooking (1997) supports this idea, and adds that it is important to provide valuations of stocks of intangible assets, because managers need to identify their most valuable resources. Moreover, knowing how valuable these resources are, it is important to identify how they might be used in the value creation process. When creating value, competitive advantage is achieved with the best use of intangibles Bontis, (2002) Accounting Perspectives As befits the importance claimed for intellectual capital, there have been numerous insights on the issues involved in accounting for it. For Brooking (1997) the development of an appropriate monetary unit of measurement is necessary in order to calculate the success and the growth of stocks of intellectual capital. In this way she embraces the traditional (monetary) valuation perspective that has served financial accounting and reporting so well for generations. When confronted with contemporary examples of intellectual capital such as 8

19 corporate reputation, that is, how customers, investors, employees, suppliers, analysts, the public, the media or regulatory bodies see the company, the capacity to be in a position to provide credible, reliable information has a potentially deep impact in the business opportunities and in the ability to attract the resources to finance those opportunities Hannington, (2006). In relation to reporting IC, Guthrie et al (2006) refer to stakeholders and legitimacy theory. The stakeholders theory provides the right to all stakeholders to obtain information related to organizational activities and its impact on their interests, even if they do not choose to utilize that information or do not have the authority to play a constructive role in the organization Deegan, (2000). The theory of the stakeholder includes all stakeholders, including potential and current investors, customers, creditors, employees, suppliers, government, and the public Donaldson and Preston, (1995). The stakeholders theory creates organizational responsibility for the voluntary disclosure of information about intellectual, social, and environmental performance other than statutory requirements to make the disclosure as transparent as possible. Guthrie et al (2006). In the same way, the legitimacy theory creates a social contract between the firm and the surrounding community in which it operates. From the perspective of this theory, a firm should voluntarily report on all those activities if the management feels that the community expects any specific report Deegan (2000). Legitimacy theory is closely tied to the reporting of IC. Guthrie et al, (2006). 2.3 Empirical Review Various scholars have examined the impact of IC on a firm performance in the past. However, most of the past studies done focus on the impact of IC on the profitability, 9

20 productivity and the competitive advantage of a firm. Very few researchers focused on the impact of IC on the firms market value. Shiu (2006) carried out a survey on 80 Taiwanese listed technological firms for year 2003 and measured their value creation efficiency with the help of new accounting measurement tool of IC (VAIC TM) used by Pulic in his various researches. The principle purpose of his research was to explore the influence of VAIC index on profitability, productivity and market valuation. He used correlation and multiple regression analysis for empirical analysis. He found that VAIC had significant positive influence on profitability and market valuation, while negative relationship with productivity. Chang and Hseih (2011) did a similar study on companies listed in Taiwan Securities Exchange (TSE) and found out that IC is associated and has impact on both financial and market performance of Taiwan companies. Firer and Williams (2003) carried out a research on South African business firms that were heavily dependent on intellectual capital. The basic purpose of their research was to explore the association between traditional measures of corporate performance: productivity, profitability and market valuation and human capital, structural capital and physical capital (major components of firm recourse base).they used linear multiple regression analysis and correlation for empirical analysis.they found that physical capital significantly associated with corporate performance, while the relationship between other variables and corporate performance was mixed and limited. Hang (2009b) investigated the impact of intellectual capital on financial aspects of firm performance and also identified the driving role of IC components for the leading role of financial indicators of companies listed in the Hong Kong stock exchange. He collected the 10

21 data from 2001 to 2005, and used VAIC methodology for measurement of intellectual capital. Four financial performance measures were selected, and impact was examined through multiple regression models. He found no significant association between intellectual capital performance and financial performance of these listed companies, except the moderate relationship between profitability and IC. His research also revealed that companies highly regarded physical capital than other capitals for enhancing their market value. Dimitrios et al (2011) conducted a research on a sample of 96 Greek companies listed in Athens stock exchange to examine the impact of intellectual capital on performance of firm. They analyzed the data with the help of multiple regression and their results indicated the existence of a significant relationship between one of the three components of IC (human capital efficiency) and one of the three indicators of financial performance (ROE). However results could not confirm the inter relation between IC and market value. Abdullah and Coskun (2007) conducted a research on quoted banks on Istanbul stock exchange market to measure their intellectual capital performance, and also the effect of intellectual capital efficiency on financial performance. Data were taken for the period , and VAIC TM is used for measurement of intellectual capital and data envelopment analysis is used for testing the impact of intellectual capital on profitability. They found that the effect of intellectual capital on profitability on the banking sector on the ISE was approximately 61.3 percent. Their findings indicated that IC seems to be a more important factor than physical capital for banks. They also observed the effect of intellectual capital on investor s behavior. 11

22 Banimahd et al (2012) did a study on Iranian high Knowledge-Based Industries on the impact of intellectual capital on profitability, productivity and market valuation. Data was taken from 68 listed companies in Tehran Stock Exchange between year 2001 and Pulic (2000) VAIC model was used. The results showed that IC has an impact on profitability and productivity but no effect on the market value of a firm. The few empirical studies related to IC in the Kenyan scenario focused on its impact on financial performance e.g. the influence of intellectual capital on the growth of small and medium enterprises in Kenya by Ngugi et al (2012) where it was evidenced that IC has a positive impact on the growth of SMEs in Kenya. I am yet to come across a research on the impact of IC on market value in the Kenyan scenario. 2.4 Intellectual Capital There are varied definitions of IC by different. Brooking, (1996) defines IC as the term given to the combined intangible assets of market, intellectual property and human resource and infrastructure which enable the company to function. Roos et al (1997) states that IC includes all the processes and the assets which are normally not shown on the balance sheet and all intangible assets which modern accounting methods consider. It includes the sum of the knowledge of its members and the practical translation of his/her knowledge. Stewart, (1997) views IC as the intellectual material that can be put to use to create wealth. It is a collective brainpower or packaged useful knowledge. Bontis, (1998) defines IC as the pursuit of effective use of knowledge which is the finished product as opposed to information the raw material. IC is regarded as an element of the company s market value as well as a market premium Olve et al., (1999). Cohen et al. (1993) warn that just like the human body s muscles, IC suffers from if you do not use it, you lose it. The Gottilieb Duttweiler Foundation (a Swiss think-tank) undertook 12

23 studies into IC and found that only 20% of knowledge available to an organisation is actually used Brooking (1997). It is within this context that the desire to model and measure IC originates. Researchers and practitioners alike are charmed by the vast opportunity that IC can offer for both knowledge generation and value-added services respectively. Generally, researchers in the field have identified three main constructs of IC that include: human capital, structural capital and customer capital Human Capital Quite simply, human capital represents the individual knowledge stock of an organisation as represented by its employees Bontis et al., (2001). Roos et. al. (1997) argues that employees generate IC through their competence, their attitude and their intellectual agility. Competence includes skills and education, while attitude covers the behavioural component of the employees work. Intellectual agility enables one to change practices and to think of innovative solutions to problems. Even though employees are considered the most important corporate asset in a learning organisation, they are not owned by the organisation. Slavery is over after all, but there is still tremendous argument as to whether new knowledge generated by employees belongs to the company or not (i.e., a software programmer develops code while at home on the weekend yet the company still lays claim to the codified knowledge). Similarly, Hudson (1993) defines human capital as a combination of: genetic inheritance; education; experience, and attitudes about life and business. Bontis (1998) describes human capital as the firm s collective capability to extract the best solutions from the knowledge of its individuals. Unfortunately, people s departure can result in the loss of corporate memory and hence become a threat to the organisation. Another school of thought believes that the departure of some individuals in a firm may be considered good, since it forces the firm to consider fresh new perspectives from replacement employees. Bontis (1999) argues that 13

24 human capital is important because it is a source of innovation and strategic renewal, whether it is from brainstorming in a research lab, daydreaming at the office, throwing out old files, reengineering new processes, improving personal skills or developing new leads in a sales rep s little black book. The essence of human capital is the sheer intelligence of the organisational member Structural Capital Structural capital includes all the non-human storehouses of knowledge in organisations which include the databases, organisational charts, process manuals, strategies, routines and anything whose value to the company is higher than its material value. Roos et al. (1998: 42) describe structural capital as what remains in the company when employees go home for the night. Structural capital arises from processes and organisational value, reflecting the external and internal foci of the company, plus renewal and development value for the future. According to Bontis (1998), if an organisation have poor systems and procedures by which to track its actions, the overall intellectual capital will not reach its fullest potential. Organisations with strong structural capital will have a supportive culture that allows individual to try new things, to learn, and to fail. Structural capital is the critical link that allows IC to be measured at the organisational level of analysis Customer Capital The main theme of customer capital is the knowledge embedded in the marketing channels and customer relationships that an organisation develops through the course of conducting business. Customer capital represents the potential an organisation has due to ex-firm intangibles Bontis, (1999). Although originally conceptualised by Hubert Saint-Onge while at CIBC, more recent definitions have broadened the category to include relational capital which in effect encompasses the knowledge embedded in all the relationships an organisation 14

25 develops whether it be from customers, from the competition, from suppliers, from trade associations or from the government Bontis, (1999). One manifestation of relational capital that can be leveraged from customers is often referred to as market orientation. There is no consensus on a definition of market orientation but Kohli and Jaworski (1990) define it as the organisation-wide generation of market intelligence pertaining to the current and future needs of customers. Ultimately, the dissemination of this intelligence must be done horizontally and vertically within the organisation so that a competency in organisation-wide action or responsiveness to market changes can be developed. Recent work in the service profit chain has emphasised the causal relationships among employee satisfaction, customer satisfaction, customer loyalty and financial performance Kaplan and Norton (1996). For example, we know that rapid delivery satisfies customers Olve et al. (1999). We also know that companies often have difficulty in retaining employees because they have not put enough time and energy in ensuring that the mission and values are truly shared Senge (1990). Further research shows that customer loyalty can be predicted by measuring employee loyalty Horibe (1999). These studies provide further evidence of the importance that customer capital represents as a unit of an organisation s overall IC Measurement of Intellectual Capital Most researchers, e.g. Firer and Stainbank, (2003) and Kamath,(2008). adopt Pulic, (2000) Value Added Intellectual Coefficient model (VAICTM) at measure IC indicator. This model is very effective because its base measurement is standard and constant; this helps in 15

26 comparing large samples from different industries. It s also objective because all the data is extracted from the financial statements. The Pulic s (2000) model uses human capital, structural capital and physical and financial capital as measures of value creation. It defines value add by the equation: VA=W+I+DP+T+R Where VA is the value added, W is salaries and wages, I is interest expenses, DP is depreciation expenses, DIV is dividends, T is corporate taxes and R is retained earnings for the year. The human capital efficiency (HCE) is the ratio of total value added to total salaries and wages. Capital Employed Efficiency (CEE) is the ratio of total value added to book value of assets. To calculate the Structural Capital Efficiency (SCE) first, total of salaries and wages are deducted from total amount of value added, then, the result should be divided by total value added. This ratio indicates how much of value added was generated by structural capital. Finally, value added intellectual coefficient is calculated by the equation VAICTM= HCE + SCE + CEE. This coefficient represents the efficiency and ability of the firm s resources, tangible and intangible, in value creation for the firm. If this coefficient is high, it indicates that management has used the firms resources efficiently. 2.5 Market Valuation Company's market value is useful to provide information about the company's performance in the past and its prospects in the future. The market value can be measured using the ratio of market value (market value ratio). According to Gitman (2009) Market ratio is relate a firm's market value, as measured by its current share price, to certain accounting value. Ratio 16

27 used to measure a company's market value in this study is the market-to-book ratio. This ratio provides assessment of how investors view the company's performance and expect a high return in accordance with the risks Gitman (2009). The selection of market-to-book ratio as a measure of the company's market value is based on research that has been done before. Solikhah (2010) analyzed the effect of intellectual capital to financial performance, growth, and market value of the companies listed on the Stock Exchange, Chan (2009) that uses market-to-book ratio as a measure of market valuation in the company's intellectual capital to analyze the impact on organizational performance. Rakhman and Margaretha (2006) in analyzing the influence of intellectual capital to market value and financial performance of companies with a method of Value Added Intellectual Capital (VAICTM). Zeghal and Maaloul (2010) also use market-to-book ratio as a proxy for stock market valuation in analyzing the value added as an indicator of intellectual capital and its consequences on company performance. 2.6 Summary of Literature Review The impact of IC on firm s performance has been investigated at both theoretical and empirical levels. Theoretical level attempts to help managers and decision makers to understand what IC is. What are its impacts on firm s performance? How can they indentify, measure and manage IC? How can they design a strategy based on IC to improve firm s performance? How can they design a plan for protecting and creating IC Schiuma and Lerro,(2008)? From a theoretical standpoint, researchers discuss that IC can create value and competitive advantages for firms. 17

28 Today, firms trying to achieve superior performance should focus on sustainable competitive advantages (Stewart, 1997). Wiig (1997) points out that today s managers try to find better theories and approaches to improve their firm s performance. The CEOs of large US firms suggest that the performance of firms in the new economy depends on two elements. The first factor is the quality of knowledge-based assets from a competitive aspect within the firm, and the second factor is the ability of a firm to use its knowledge-based assets to create value and wealth, (Banimahd, et.al, 2012). At empirical level there has been a lot of focus on the influence of IC on a firm s performance with reference to the profitability and productivity. There seem to be a consensus that IC has a positive effect on a firm s productivity and profitability. However there has been little focus on the effect of IC on a firm market value. Different empirical studies on the effect of IC on market value show significant different results. 18

29 CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter discuss the research methodology used in the research; it adopted the following structure: the research design, population and sample, data collection methods, research procedures and data analysis methods that was followed in the research process. All guided the implementation of the research study towards the realization of the objectives. 3.2 Research Design The purpose of this study was to determine the impact of IC market valuation of firms listed in the Nairobi Securities Exchange from 2002 to This was a descriptive study that involved the use of descriptive statistics and hypothesis techniques in order to answer the research questions. 3.3 Population There were 62 listed companies in the NSE as at 31 st December 2012 according to the NSE website. This was the population of interest for the purpose of this study. 3.4 Sample Design Due to the heterogeneity among the companies listed in the NSE, consider some special factors were considered when choosing the companies. First, companies must be listed on NSE since Second, 31 st December must be the end of company s financial year, and it must have remained unchanged in the study's period. A census study was done on all the firms that fitted the selection criteria. 19

30 3.5 Data Collection This study employed secondary data based on the annual financial statements and reports of all the companies in the sample. All firms listed in the NSE are required to present audited annual financial statements and there the data was objective and available. The market value of the selected firms was based on the NSE listed prices as at 31 st December of every year from Data Analysis In this study, a model was estimated and hypotheses tested by regression and correlation analyses. Multiple-linear-regression method was applied. Finally, regression's assumptions was tested and controlled. Inference about the test was based on a significant level which was obtained from the test. Thus, whenever the amount of the significant level is less than 5 percent null hypothesis on 95 percent level was accepted. The multiple-linear-regression was as follows: 1. M/B = α+ β 1 VAIC + µ 2. M/B = α+ β 1 (HCE) it + β 2 (SCE) it + β 3 (CEE)A it + β 4 (Size)+ β 5 (LEV)+ µ Where: M/B = Market to Book value ratio β 1, β 2, β 3, β 4 β 5 = The independent variables coefficients in models. μ = models error and α is the constant term. Total Value Added (VA) =W+I+DP+T+DIV+R (refer to abbreviations) HCE it =Human Capital Efficiency for firm i at period t measured by the ratio of Total Value Added to Salaries and Wages (W) 20

31 SCE it = Structural Capital Efficiency for firm i at period t measured by Total Value Added divided by Total Value Added minus Salaries and Wages (W). This ratio indicates how much of value added was generated by structural capital. CEE it = Capital Employed Efficiency for firm i at period t measured by Total Value Added to Book Value ratio. VAIC= Value Added Intellectual Coefficient VAIC = HCE+SCE+CEE Size and LEV are the control variables measured natural logarithm of total assets for firm i in year t and total liabilities to total assets firm i in year t respectively. 21

32 CHAPTER FOUR: DATA ANALYSIS AND PRESENTATION OF FINDINGS 4.1 Introduction This chapter presents the research findings on the effect of intellectual capital on the market value of a firm and the effect of individual components of intellectual, that is, human capital, structural capital efficiency and capital employed on the market value of a firm. The study was conducted firms listed at the NSE where secondary data from the period of 2003 to 2013 was used in the analysis. The regression analysis was done for the ten years period. 4.2 Data Presentation Regression Analysis for Year 2003 Table 4.1: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 67.8% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 67.8% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of

33 Table 1: Coefficients Model Un-standardized Coefficients Standardized Coefficients B Std. Error Beta 1 (Constant) Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage t Sig. The established regression equation was for years 2003 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.652, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by 0.281units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression Analysis for Year 2004 Table 4.2: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a Adjusted R 2 is called the coefficient of determination it show how change in the independent 23

34 variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 71.2% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 71.2% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 2: Coefficients Model Un-standardized Coefficients Standardized Coefficients T Sig. B Std. Error Beta 1 (Constant) Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2004 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.652, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to 24

35 increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by 0.480units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression Analysis for Year 2005 Table 2.3: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1.927(a) Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 84.1% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 84.1% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 3: Coefficients Model Un-standardized Coefficients Standardized Coefficients T Sig. 1 B Std. Error Beta Constant Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage

36 The established regression equation was for years 2005 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.417, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression Analysis of Year 2006 Table 4.4: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1.908(a) Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 80.1% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 80.1% of change in market value of firm listed in the NSE could be accounted for by changes in the 26

37 human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 4: Coefficients Mode l Un-standardized Coefficients Standardized Coefficients t Sig. 1 B Std. Error Beta Constant Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2006 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.533, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units. 27

38 4.2.5 Regression Analysis for Year 2007 Table 4.5: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1.892(a) Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 75.3% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 75.3% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 5: Coefficients Model 1 Un-standardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta Constant Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2007 Y = X X X X X 5 28

39 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.408, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression Analysis for Year 2008 Table 4.6: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1.987(a) Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 95.8% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 95.8% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of

40 Table 6: Coefficients Mode l Un-standardized Coefficients Standardized Coefficients T Sig. 1 B Std. Error Beta Constant Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2008 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.287, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression analysis for Year 2009 Table 4.7: Model Summary 30

41 Model R R Square Adjusted R Square Std. Error of the Estimate a Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 80.7% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 80.7% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 7 : Coefficients Model Un-standardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2009 Y = X X X X X 5 31

42 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.361, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression analysis for Year 2010 Table 4.8: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 56.5% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 56.5% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital 32

43 and market value of a firm as shown by correlation coefficient of Table 3: Coefficients Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2010 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.364, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units. 33

44 4.2.9 Regression analysis for Year 2011 Table 4.4: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate a Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 60.4% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 60.4% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital and market value of a firm as shown by correlation coefficient of Table 4.9: Coefficients Model Unstandardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 (Constant) Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years

45 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.201, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units Regression Analysis 2012 Table 4.10: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1.891(a) Adjusted R 2 is called the coefficient of determination it show how change in the independent variable results to changes in the dependent variable. From data, the value of adjusted R 2 is This implies that, there was a variation of 74.5% of market value of firm listed in the NSE dues to changes in human capital efficiency, structural capital efficiency, capital employed, size and leverage at 95% confidence interval, this is an indication that 74.5% of change in market value of firm listed in the NSE could be accounted for by changes in the human capital efficiency, structural capital efficiency, capital employed, size and leverage, the study also found that there is a strong positive relationship between intellectual capital 35

46 and market value of a firm as shown by correlation coefficient of Table 10: Coefficients Model Un-standardized Coefficients Standardized Coefficients t Sig. B Std. Error Beta 1 Constant Human Capital Efficiency Structural Capital Efficiency Capital Employed Efficiency Size Leverage The established regression equation was for years 2012 Y = X X X X X 5 From the above regression model, holding human capital efficiency, structural capital efficiency, capital employed, size and leverage to constant zero, the market value of a firm of firm listed at the NSE would stand at 0.298, a unit increase in human capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in structural capital efficiency would lead to increase in market value of a firm listed at the NSE by units, a unit increase in capital employed efficiency would lead to increase in market value of a firm listed at the NSE by units, unit increase in size of the firm would lead to increase in market value of a firm listed at the NSE by units and further unit increase in leverage of the firm would lead to decrease in market value of a firm listed at the NSE by units. 36

47 Tests of the assumptions of the regression models The table below shows that the coefficient of determination (the percentage variation in the dependent variable being explained by the changes in the independent variables) for the listed companies at Nairobi securities exchange. Normality of the variables was examined using the skewness and kurtosis. According to Kline (2011), the univariate normality of variables can be assumed if the skewness statistic is within the interval (-3.0, 3.0) and the kurtosis statistic lying in the interval (-10.0, 10.0). Histograms on Normality test The issue of multi-collinearity may arise if two or more variables was be highly correlated. It may affect the estimation of the regression parameters (Hair et al., 2010). Multicollinearity was tested by examining the correlation coefficient. Granger causality Wald tests Equation Excluded chi2 df Prob > chi2 Human Capital Efficiency Market value Structural Capital Efficiency Market value Capital Employed Efficiency Market value Human Capital Efficiency all Structural Capital Efficiency all Capital Employed Efficiency all