Studies on the Value Relevance of Other Intangible Assets

Apart from R&D costs, other types of intangible assets examined include identifiable intangible assets (Ely and Waymire, 1999b; Zaleha, Muhd-Kamil, Jagjit and Hamezah, 2008) and other specific classes of identifiable intangible assets such as software development costs (Aboody and Lev, 1998) and brand names (Barth, Clement, Foster and Kasznik, 1998; Kallapur and Kwan, 2004) as well as other non- financial intangible assets (Deng, Lev and Narin, 1999; Trueman, Wong and Zhang, 2000; Rajgopal, Venkatachalam and Kotha, 2003).

Ely and Waymire (1999b), for example, investigate the association between capitalised intangible assets and stock price and reported earnings during the period prior to the establishment of the SEC. This is the period in which management was given considerable discretion to capitalise a wide range of intangible assets and to determine subsequent amortisation and revaluation policies for these assets. The tests conducted involve: (1) the regression of share price against capitalised intangible assets, earnings, book values, book value of tangible assets; and (2) the association between reported earnings and capitalised intangible assets. Based on a sample of 146 NYSE firms trading in 1927 that capitalised their intangible assets, no evidence is found to support an association between capitalised intangibles and share price. Instead, the findings show that the coefficient relating earnings to share price is a declining function of the level of capitalised intangibles. Sensitivity tests also indicate that the negative earnings-capitalised intangible assets interaction remains robust after the inclusion of a variable related to risk or earnings management incentives. Similar to Cazavan-Jeny and Jeanjean (2006), the authors conclude that

this is consistent with investors’ perceptions that capitalisation of intangible assets allows managers to overstate earnings.

A study conducted in Malaysia that permitted managerial discretion in accounting for intangible assets also provides no evidence of value relevance of such assets (Zaleha et al., 2008). Specifically, using a sample of 4,095 firm-years listed on the main board of Bursa Malaysia throughout a 12-year period from 1990 to 2001, the authors investigate the value relevance of intangible assets across three different economic and accounting environment conditions. These are: (1) strong economic conditions but with less stringent accounting regulations (1990-1996); (2) a financial crisis period combined with the establishment of the Malaysian Accounting Standards Board (1997-1998); and (3) a recovery economic period with a more stringent accounting regulatory framework (1999-2001). Overall, intangible assets are found to be consistently negatively associated with share prices across the three different economic and accounting periods, suggesting that the capitalisation of these assets provides no value-relevant information to investors.

Aboody and Lev (1998) examine the value relevance of capitalised software development costs in the light of the Financial Accounting Standards Board’s Statement No. 86 (SFAS 86) where managerial discretion is allowed. As mentioned in Chapter 2, software capitalisation is the only exception under U.S. GAAP to the full expensing rule of R&D costs mandated in SFAS No. 2. The sample consists of 163 firms that were publicly traded during 1987-1995, which are then classified into expensers and capitalisers. The value relevance of software development cost capitalisation is examined using three approaches: the association between capitalisation-related variables and contemporaneous stock returns, stock prices and future earnings. In addition, consistent with previous studies that examine intangible assets in an accounting regime that provides for the choice to capitalise (Cazavan- Jeny and Jeanjean, 2006; Oswald and Zarowin, 2007; Oswald, 2008), Aboody and Lev (1998) also take into account the endogenous effects of accounting choice by controlling for firm-specific characteristics.

The value relevance tests show a significant positive association between, first, the annual software cost capitalisation amount and stock returns and prices and, second, the cumulative software assets and stock returns and prices. This, in general, suggests that software cost capitalisation provides information relevant to investors. Further, software cost capitalisation data were also found to be associated with subsequent reported earnings, suggesting another dimension of value relevance to investors. This is because it is argued that if managers systematically abuse their discretion in determining technological feasibility and expected profitability of the developed projects, there should be no relation between capitalisation of development costs and subsequent performance. The findings hence provide no support for the claim that the judgement involved in software capitalisation decreases the quality of reported earnings. However, the authors suggest caution in making the generalisation to capitalisation of other intangible assets, especially R&D costs, primarily because SFAS No. 86 deals only with the capitalisation of the development expenditures incurred after technological feasibility has been achieved.

Barth et al. (1998) provide evidence relating to the relevance and reliability of estimates of brand values by investigating whether share prices and returns reflect brand values estimated by Financial World (FW), based on the methodology developed by Interbrand Ltd., an established brand valuation consulting firm. The tests are performed by estimating the association between the FW brand value estimates and share prices and the association between year-to-year changes in the brand value estimates and annual share returns. The results report consistent evidence that brand value estimates are significantly associated with equity market values in both specifications, providing evidence in support of their value relevance.

In contrast to Barth et al. (1998) who rely on the valuations of outside parties for brand-value estimates, Kallapur and Kwan (2004) examine the value relevance and reliability of brand assets recognised as part of business acquisitions. However, managers could be subject to contracting incentives to bias the brand recognition (Muller III, 1999), which suggests that there is greater concern with regard to the

reliability of acquired brand values. Therefore, Kallapur and Kwan (2004) test for the reliability of brand-asset measures by examining the differences in brand- capitalisation rates of firms with strong and weak contracting incentives. They argue that if firms with high contracting incentives over-value brands (introduce greater noise), then the stock markets should capitalise their brands at lower rates. Thus, differences in valuation biases or noise among these groups of firms would signify a lack of verifiability, which is a component of reliability. The results suggest that despite managers’ incentives to over-value them, recognised brand values are value relevant. However, it is also found that there are differences in the amount of bias or noise in brand valuations of different groups of firms, suggesting that brand-asset measures lack reliability for firms with high contracting incentives.

Due to the difficulties in estimating the value for certain types of intangible assets in monetary forms, especially internally generated intangible assets that are not recognised in the financial statements, some studies investigate the value relevance of these assets as reflected in non-financial information. These studies provide evidence that is generally consistent with intangible assets providing incremental value-relevant information beyond traditional accounting measures. Non-financial information such as various measures of patents (Deng et al., 1999), website pageviews (Trueman et al., 2000) and network advantages of e-commerce firms (Rajgopal et al., 2003) are found to be significantly associated with share prices and returns, indicating their value relevance.

3.5.3 The Impact of IFRS Adoption on the Value Relevance of Intangible