Recently, US and European institutional investors have started paying more attention to the intangible drivers of the companies in which they invest. Things like brands, sustainability, human capital, intellectual property and – of course – corporate governance are becoming more important to the decision making of institutional fund managers. In fact, 70 percent of investors polled for the IR Magazine US Awards said they wanted patents and brands to appear on the balance sheet.
The reason is simple. In the post-Enron corporate world, investors are demanding a broader assessment of companies, according to Alois Flatz, head of research at Sustainable Asset Management (SAM) in Zurich. The overwhelming feeling among buy-side investors is that financial metrics no longer provide enough indication of a company’s long-term potential.
With regulators focusing on corporate social responsibility, intensified competition among peers and increased shareholder activism, intangibles are popping up on investors’ radar screens. According to Sustainable Investment Research International Group, which measures socially responsible investment trends, there are now more than 300 European CSR funds, with a combined total of €12.2 bn ($15.5 bn) in assets under management.
In the US, the demand for information on intangibles is demonstrated by the number of sell-side firms that now include metrics which quantify drivers, like governance and brand. Wall Street behemoth Salamon Smith Barney includes Institutional Shareholder Services’ Corporate Governance Quotient in analysts’ research reports, and around 44 other investment firms include governance scores in research materials. To measure brand valuation, BNY Jaywalk, The Bank of New York’s independent equity research arm, uses CoreBrand’s measures in its research.
A growing appetite
IROs need to feed investors’ new appetite for information on intangibles. This means looking at the relationship between intangibles and shareholder value within your organization. Ask yourself things like: ‘How does our logo drive sales?’ or ‘Did the employee training make staff more efficient?’ What you need to find out is whether the money your company spends on intangibles is returned to its coffers.
‘Penetrating the veneer of shiny intangibles like patents and brands reveals a disturbing picture of negative feedback from firms to capital markets and back, leaving in its wake considerable misallocation of corporate resources and significant loss of shareholder value,’ says Baruch Lev, professor of finance and accounting at the Stern School of Business. Managers, therefore, need to understand the link between a firm’s market valuation and its investment in intangibles.
Some companies are already doing this. Pharmaceutical giant Merck, for example, spends a considerable amount on employee training, and wanted to devise an objective way to measure its effectiveness. So an internal council developed a way to measure how training programs bettered work performance as well as the dollar value of improved performance and the percentage of job skills affected by training programs. The final analysis detailed the ROI for each training program at Merck and helped the company make decisions about which programs to keep and which to end.
Regulators have yet to come up with clear guidelines for valuing intangibles, but IROs can still champion the need for better disclosure of these drivers by helping their companies move towards a process of measurement, interpretation and meaningful disclosure, leading to more informed and accurate valuations in the market.
