Intangibles: Do companies disclose relevant information?
In this article, the team of academics working on a second ICAS and EFRAG sponsored project on the topic of Intangibles, introduce the objective of their research: Do companies disclose relevant information?
In today’s business environment, a large proportion of the value creation of a business depends on intangibles and knowledge-based resources. These resources represent the main source of a company’s competitive advantage and are therefore major drivers of corporate performance. The concept of intellectual capital (IC) makes a distinction between these resources and material, physical and financial assets. IC refers to resources like know-how, relationships, expertise and skills.
While it is widely acknowledged that investors benefit from information about IC, those resources are often hard to measure and represent in financial statements. Early attempts to encourage IC disclosure in dedicated statements and reports have failed as a consequence of loose regulation, but also costs related to the disclosure of proprietary information.
In order to address the open challenges related to the reporting of intangibles, ICAS launched a call for research in 2019. The call highlighted a need to gather stronger insight into how companies can explain how intangibles contribute to their overall value creation; particularly in the case of intangible-intensive companies.
The project and the research team
This project sponsored by ICAS and the European Financial Reporting Advisory Group (EFRAG) addresses concerns outlined in the call for research. The research team, composed of Chiara Crovini (Aalborg University Business School), Francesco Giunta (University of Florence), Christian Nielsen (principal investigator, Aalborg University Business School), and Lorenzo Simoni (University of Genoa), is currently investigating the IC reporting practices of a sample of high-tech listed companies based in the UK and selected EU countries. The EU Directive 95/2014 and the Companies Act in the UK requires companies to disclose, among other items, information about business model and risks, which are closely linked to value creation.
Users of corporate information need to be able to understand how IC creates and delivers value and how a company can capture the value on the one hand, and on the other hand how it utilises and protects IC resources. The research therefore explores whether and how companies are taking advantage of the mandatory requirements concerning business model reporting and risk reporting as defined by recent non-financial regulations, to disclose information about their IC.
While the business model explicitly defines and illustrates the main value drivers of a business, risk reporting addresses the main threats and opportunities relating to the company’s ability to exploit and protect those value drivers. As IC represents a significant source of competitive advantage, companies should ideally offer an integrated communication, where both business model reporting and risk reporting address the main IC elements contributing to a firm’s value creation. Thus, IC is a natural link between business model reporting and risk reporting. As a consequence, we would expect that if an IC element is identified as a key element of the business model and consequently recognised as a key factor that drives value, risks related to the IC element should be disclosed in the relevant section in the annual report. This is studied in detail in our sample of companies across Europe and the UK.
Against this backdrop, the aim of this project is twofold:
- First, it examines whether and to what extent companies provide information about IC elements in the sections devoted to the business model and risks.
- Second, it assesses the correspondence between the IC elements presented in the business model section and those reported in the risk section.
This research project examines how large high-tech companies currently report on their intangibles, and how this disclosure is correlated with reporting about their business models and risks, both of which have become mandatory in the UK and all the EU member countries.
A novelty of the research proposal is that business model reporting and risk reporting are considered as strictly intertwined. The proposed model maintains that companies should:
- offer a description of the main IC elements they rely on to create and deliver value in the BM section of the annual report;
- illustrate the risks associated with the main IC elements that drive a company’s value in the section devoted to risks.
As regulators have emphasised the linkages among different non-financial items disclosed, by affirming that companies should offer an integrated and internally consistent non-financial disclosure, the results of the project will be able to inform the development of guidelines to assist companies in effectively representing their IC, using the business model as a context for this as well as other types of information.
Another aim of the project is to clarify how companies use risk reporting to address IC and inform investors about the opportunities related to IC elements. In a not-so-distant future, research indicates that business model reporting that factors in the exact business model configuration that a given company is based on and uses this as a basis for disclosure and performance benchmarking will be a game-changer for corporate transparency and communication within and outside of capital markets across the globe.
Look out for the findings and recommendations from this research by Summer 2021.