Sell-side analysts’ use and communication of intellectual capital information Subhash Asanga Abhayawansa A thesis submitted in partial fulfilment of the requirements for the degree of Doctor of Philosophy Discipline of Accounting, Faculty of Economics and Business, University of Sydney, Sydney, Australia March 2010 Statement of Originality This is to certify that to the best of my knowledge, the content of this thesis is my own work. This thesis has not been submitted for any degree or other purposes. I certify that the intellectual content of this thesis is the product of my own work and that all the assistance received in preparing this thesis and sources have been acknowledged. Subhash Asanga Abhayawansa March, 2010 ii ACKNOWLEDGEMENTS I would like to express my appreciation and gratitude to several people, without whom this thesis may not have been a reality. Firstly, my most sincere thanks to my main supervisor Professor James Guthrie for accepting me as a PhD student and for his unwavering support and guidance throughout the project. His advice and detailed comments on previous drafts of this thesis undoubtedly improved its standard substantially. I am indebted to Associate Professor Indra Abeysekera, who supported me in obtaining the PhD candidature at the University of Sydney and was my associate supervisor in the initial years of the thesis. I am thankful to him for being there for me whenever I needed guidance, advice and support. Also, I am thankful to Professor Suresh Cuganesan, who became my associate supervisor in the later stages of my candidature, for guiding me in the right direction and providing insightful comments on previous versions of this thesis. I thank Professor Louise Kloot and Associate Professor Irene Tempone for approving six months leave from work and being supportive of me. This six-month period was the most productive period in the write up of my thesis. I am also thankful to Fiona Crawford for her editorial assistance. I am especially thankful to my parents, Sunitha and Kapila. Without their love, support and inspiration I would not have come this far in my life. It is my father, himself a renowned scholar, who inspired me to pursue a career in academia. I thank him for this. Also, a special thank to my mother-in-law Rupa. All her support made our lives so easy in Australia, and undoubtedly fast tracked the completion of this thesis. I am extremely grateful to my wonderful wife Rukni. I thank her for the support she extended in a myriad of ways to see this thesis to completion. My two beautiful children, Nishka and Aakash, deserve special thanks too. Their love and energy kept me going. iii TABLE OF CONTENTS 1. BACKGROUND AND MOTIVATION .................................................. 1 1.1. Introduction........................................................................................................1 1.2. Background........................................................................................................1 1.3. Overview of the research ...................................................................................6 1.4. Motivations for the research ..............................................................................7 1.4.1. The knowledge gap......................................................................................8 1.4.2. Potential benefits..........................................................................................9 1.5. Sell-side analysts – work, roles and influences ...............................................10 1.5.1. Introduction to sell-side analysts ...............................................................11 1.5.2. Sell-side analysts’ role in the capital market .............................................12 1.5.3. The analyst report ......................................................................................14 1.5.4. Influences on sell-side analysts..................................................................18 1.6. Outline of the thesis .........................................................................................21 1.7. Chapter summary.............................................................................................22 2. A LITERATURE REVIEW ON INTELLECTUAL CAPITAL ........ 24 2.1. Introduction......................................................................................................24 2.2. IC concept and classification ...........................................................................24 2.2.1. Intangibles..................................................................................................25 2.2.2. Intellectual capital......................................................................................27 2.2.3. Classification of IC ....................................................................................29 2.3. Initiatives on ICR.............................................................................................37 2.4. Initiatives promoting the use of IC information ..............................................40 2.4.1. AIAF (2002) ..............................................................................................41 2.4.2. DMSTI (2003) ...........................................................................................42 2.4.3. EAI (2004) .................................................................................................44 2.5. ICR practices....................................................................................................44 2.5.1. ICD in corporate annual reports.................................................................45 2.5.2. ICD in IPO prospectus...............................................................................47 2.5.3. ICD on company websites .........................................................................48 2.5.4. ICD in presentations to analysts ................................................................49 iv 2.5.5. ICD in company announcements...............................................................50 2.6. Chapter summary.............................................................................................50 3. A REVIEW OF THE USE OF IC INFORMATION........................... 52 3.1. Introduction......................................................................................................52 3.2. Capital markets research on the importance of IC...........................................52 3.2.1. IC and the price-to-book ratio....................................................................53 3.2.2. Value-relevance of IC................................................................................55 3.2.3. Predictive ability of IC...............................................................................60 3.3. Importance of types of information to sell-side analysts.................................61 3.3.1. Sell-side analysts’ use of financial and non-financial information............62 3.3.2. Importance of types of IC information ......................................................64 3.4. How sell-side analysts use IC information ......................................................76 3.4.1. Company valuation....................................................................................76 3.4.2. Role of IC in sell-side analysts’ company research...................................79 3.5. Gaps in the literature and research objectives .................................................82 3.5.1. Importance of IC information....................................................................82 3.5.2. How IC information is communicated.......................................................87 3.5.3. Determinants of use of IC information......................................................89 3.6. Chapter summary.............................................................................................89 4. HYPOTHESES DEVELOPMENT AND TESTING ........................... 91 4.1. Introduction......................................................................................................91 4.2. Development of hypotheses.............................................................................91 4.2.1. Impact of firm size on the use of IC information ......................................91 4.2.2. Impact of profitability on the use of IC information .................................94 4.2.3. Impact of firm’s systematic risk on the use of IC information..................96 4.2.4. Impact of firm’s sector on the use of IC information ................................97 4.2.5. Impact of analyst recommendation type on the use of IC information ...100 4.3. Testing of hypotheses ....................................................................................101 4.3.1. Selection of statistical techniques............................................................101 4.3.2. Dependent variables.................................................................................102 4.3.3. Independent variables ..............................................................................102 v 4.4. Chapter summary...........................................................................................106 5. RESEARCH METHOD........................................................................ 107 5.1. Introduction....................................................................................................107 5.2. Content analysis.............................................................................................107