Some experts believe even half measures like the FASB’s and the SEC’s are a step in the right direction. But the risk of such half measures is that they can be perceived as an acceptable solution, when in fact they only obfuscate the issue.
Valuing an Intangible
In 2004, the Economist Intelligence Unit conducted a survey of senior managers on intangibles. A whopping 94 percent of respondents said that managing intangible assets or intellectual capital is important. More than one-third ranked it as one of the top three management issues. In fact, nearly half of the respondents said they considered intangibles to be the primary source of long-term shareholder wealth creation for their companies.
But when asked about the systems they used to measure the performance of this important class of assets, 95 percent of the executives surveyed said they did not have such a system in place. “They know it’s important. But if they don’t have to disclose it, they don’t measure it internally either,” says Kenan Patrick Jarboe, executive director of the nonprofit Athena Alliance in Washington, which publishes reports on intangible assets and other aspects of the global economy. “I’m just waiting for somebody to get sued under Sarbanes-Oxley because they didn’t disclose that 80 percent of their patents are worthless.”
Even if disclosure issues were addressed, the valuation process itself is far from obvious. “Putting a number on intangibles is the difficult part,” says Jarboe. “This is partly because these things get bundled together. We can put a value on a patent, but how much of that value can I pull out and say, ‘The metal that makes up this six-axis remotely programmable lathe is worth $20, but the knowledge required to make it is worth $2,000’? It’s hard to separate them.”
If today’s accounting rules don’t work for intangibles, what valuation methods do work? According to Jarboe, any credible rating tool for intangibles must have three components. The first, and most critical, is transparency. “The process itself has to be transparent, and the assumptions you make in order to come up with the value have to be transparent,” he says. Second is a clear definition. “Separability is important,” he says. “If you say your entire corporate culture is an intangible asset, what does that mean? It has to be definable to differentiate it from other assets.”
Finally, a good rating tool has to quantify the value of intangible assets. “This is the trickier part — some intangibles can be quantified a lot easier than others, and the quantifiability of some of them is changing,” Jarboe says. For example, there has always been a market for patents, but it has traditionally been a “craft-like” market — more art than science, and certainly offering nothing like the comparability that determines prices in, say, the housing market. Without a central clearinghouse like those for houses or stocks, a place where sellers can go to list a patent for sale, it’s a world of “one-off deals, a hunter–gatherer market,” as Jarboe puts it. But market mechanisms, like patent clearinghouses, are starting to emerge; once they do, pricing mechanisms, comparability, and better valuations will follow.
More than a dozen approaches have been developed to measure and report intangible assets. But according to a 2005 report on intangibles by Rob McLean for the Value Measurement and Reporting Collaborative, a multinational organization of accounting bodies, the results derived from one approach have virtually nothing in common with results from another. Some models, including the balanced scorecard framework, link intangibles to performance by measuring key indicators, such as reductions in the cost of safety management or in customer complaints. Others use value drivers, such as sales growth or gross margins, or various “capitals” (such as human, intellectual, or social capital) to value intangibles. And although all approaches (except traditional accounting, of course) recognize the importance of broader context in setting a value, each has developed its own way for dealing with and representing that context. Such fundamental differences derail the potential for each approach to inform a broader economic conversation about intangible value. Nonetheless, the best of them seem to be tremendously useful to the companies that deploy them.