5. The role of financial analystsy
Financial analysts may and should play a key role in
identifying WHAT to report and HOW toidentifying WHAT to report and HOW to
communicate on the new value drivers
Research has demonstrated a relatively weak attitude Research has demonstrated a relatively weak attitude,
lacking proactivity vis‐à‐vis (e)‐valuation of
intangiblesintangibles
6. Standard & Poor’s Moody’s Fitch Ratings
HUMAN CAPITAL - Management track record
- Risk tolerance
- Management track record,
motivation, quality
- Management track record and
flexibility, q y
- Risk tolerance
- Turnover
- Risk tolerance
RELATIONAL - Customer service
Product innovativeness quality and
- “Franchise strength”
(Products’ quality &
- Market share
Capacity to influence price
CAPITAL
- Product innovativeness, quality and
price, distribution capabilities
- Reputation/External image
(Products’ quality &
innovativeness,
diversification in general,
distribution strategy)
- Brand and IP
- Capacity to influence price
- Marketing expenses
- Products leadership degree
- Reputation
G hi l di ifi ti- Brand and IP
- Client service
- Geographical diversification
- Others
ORGANISATIONAL
CAPITAL
- Size (impact on the financial
flexibility)
- Diversification
- Product/service innovativeness
(also R&D expenses)
- Size (impact on the financial
- Size (impact on the financial
flexibility)
- Product/service diversificationDiversification
- Technology
Size (impact on the financial
flexibility)
- Technology
Product/service diversification
- Distribution channels
STRATEGY - Valuation of the potential credit
impact of alternative strategic
- Growth strategy
- Long-term vision
-Consistency between strategy &
organisational structurep g
initiatives
- Consistency between strategy and
organisational structure
Long term vision
- Risk-return tolerance
g
- Acquisitions
CORPORATE - Ownership structure (impact on the
fi i l fl ibilit d lidit )
- Ownership structure (impact - Similar to Moody’s
GOVERNANCE
financial flexibility and solidity) on financial flexibility & solidity)
- Equilibrium of responsibility
- Adequacy of delegation
mechanisms
Middl t i l t
6
- Middle management involvement
- Conflict of interests
Main results emerging from the content analysis of documents regarding the intangible
resources considered in the credit rating process – Source: in Zambon and Marzo, 2007
7. HUMAN CAPITAL Confirmed the relevance of managers’ track record as proxy of competence, ability, etc.
Less attention on the other employees’ skills and capabilities
Training activity scarcely analysed (just in case of problems)
RELATIONAL
CAPITAL
Sales and Market share
Customer satisfaction (derived indirectly form sales)/ reputation (impact on financial stability)
Brand (in terms of capacity to maintain o increasing the product price)
Dependence on one or few clients/suppliers (negative/risk implication)/ Diversification is positivep pp ( g p ) p
Internationalisation (positive, risk implication)
No internal image (of the employees), just a focus on turnover in some critical cases
Relations with Unions (only it is a source of instability)
Marketing e penses: not cr cialMarketing expenses: not crucial
Communication:
- External: scepticism towards supplementary statements (social/environmental/sustainability, etc.)
- Internal: just if problematic (consistency of management objectives with strategy)
ORGANISATIONAL
CAPITAL
R&D always important (comparative analysis by industry)
Technology, according to the industry
Level of innovativeness (can increase the risk)
Diversification (both geographical and of products) is always positive( g g p p ) y p
Change in corporate culture (motivation and management)
Ownership structure
Personnel compensation mechanisms
Ri k t l /St l f t ( i i i k )STRATEGY Risk tolerance/Style of management (aggressive is more risky)
Cohesion/coherence between strategy and culture/Feasibility of strategy
CORPORATE Relevant, especially the ownership structure, in terms of financial solidity.
Also board composition no of meetings audit committee expertise and independence executive
7
GOVERNANCE
Also board composition, no. of meetings, audit committee expertise and independence, executive
compensation strategies
Main results emerging from the interviews with the analysts regarding the intangible aspects
considered in the credit rating process by the 3 top agencies
8. Overview of selected initiatives
I li F d i f Fi i l A l (AIAF) Italian Federation of Financial Analysts (AIAF)
EFFAS – Ten Principles for Effective IC disclosure
WICI – Mission & Vision
Illustration
9. THE MODEL FOR RANKING IC & INTANGIBLES
DISCLOSURE by Italian Association of Financial Analysts & Univ of
Level 1
Minimal information:
- enclosed in the annual report (MD&A)
DISCLOSURE by Italian Association of Financial Analysts & Univ. of
Ferrara, 2002
enclosed in the annual report (MD&A)
- mainly orientated to actual figures
Level 2
Extended information:
LEVEL 3
Full IC Report
- enclosed in the annual report (MD&A)
- orientated also towards prospective information
- IC information is generally disclosed in ad hoc Table
Level 3
LEVEL 2
Synthetic information
ith d h t bl
Level 3
Extended and autonomous information:
- Ad hoc report on IC and intangibles
Strategy & Business Model
with an ad hoc table
in the annual report
Organisation
Innovation & IPR
LEVEL 1
Minimal information
Customers/Suppliers
Human resources
g
9
INFO ON CURRENT SITUATION PROSPECTIVE INFO
10. Recommended structure
Firm level
Metrics specific to the
firm – no limitFirm level firm no limit
Sector level
Metrics characterizing
sector
( )(20-25 max.)
General Universal metrics
(3-5 max )(3-5 max.)
Combine specificity and comparability – Source : Zambon, WICI 10
11. EFFAS – 10 Principles for effectiveEFFAS – 10 Principles for effective
communication of IC
Why and how
the financial communitythe financial community
should tackle intangibles
– now
12. Effective communication of IC (1/10)( / )
1. Clear link to future value creation
The indicators should enhance the basis for decisions of both
internal and external parties. Only those indicators that are also used
for internal management are relevant for investors To that endfor internal management are relevant for investors. To that end,
indicators should exhibit a clear link to the company’s future value
creation.
More specifically, analysts and investors are interested in indicators
directly related to a company’s operating and/or financial market
performance. It might be necessary to further clarify this link in a
narrative fashion. In addition, an ideal indicator would be one that could
be “modelized”, i. e. included in quantitative valuation frameworks
12
13. Effective communication of IC (2/10)( / )
2 Transparency of methodology2. Transparency of methodology
Companies should explain how they have built the indicators disclosed.
“Easy to measure” often means “easy to understand” and thusEasy to measure often means easy to understand” and thus
effective in communication.
Th l l ti th d h ld b d i d f th i t l tThe calculation method should be derived from the internal management
system. This helps to ensure that the benefit attributable to the use of
the indicator exceeds the cost for obtaining the information.
13
14. Effective communication of IC (3/10)Effective communication of IC (3/10)
3. Standardisation
A transparent methodology facilitates a more fertile discussion with analysts
about the company’s potential and performance. The resulting deeper
understanding in turn enables analysts to compare different indicator
h E t ll k t f ld th l d t th fapproaches. Eventually, market forces would then lead to the emergence of a
“market best practice” in the calculation and disclosure of intellectual capital
indicators. This is a crucial step: only standardised intangibles indicators can
be benchmarked between companies and only benchmarked indicatorsbe benchmarked between companies, and only benchmarked indicators
are truly useful.
For the time being, we would prefer the market-driven approach to theg, p pp
imposition of mandatory standards on a detailed level, as leeway is still needed
for collaborative experimentation including both companies and
analysts/investors. Ultimately, we think indicator standardisation should exhibit
three levels of specificity. Indicators on the low level should be generally
applicable, i. e. they should be relevant for most or all sectors and companies.
Indicators on the middle level should be those specific to a certain sector (using
14
a sector taxonomy already broadly used in the financial community). Indicators
on the top level should be those specific to the individual company.
15. Effective communication of IC (4/10)
4. Consistency over time
The second possible dimension of benchmarking is to compare today’sThe second possible dimension of benchmarking is to compare today s
indicator values to historical ones for the same company. To enable that,
the set of indicators chosen has to be as consistent over time as
possible When a company decides to replace an indicator a rationalepossible. When a company decides to replace an indicator, a rationale
should be given (for instance, to align it to a change in the company’s
strategy).
As long as standardisation has not progressed far enough, there is a risk
of “indicator moral hazard”: We should strive to help companies counter
th b i t t ti t l i di t ith th t tlthe obvious temptation to replace indicators with new ones that currently
seem to portray them more favourably.
15
16. Effective communication of IC (5/10)( / )
5. Balanced trade-off between disclosure and privacy
Indiscriminate disclosure of information on IC could in some cases result
in competitive disadvantages. It is thus indispensable to search for the
right balance between the disclosure of intellectual capital and
privacy issues. The publication of such information should always be
preceded by a careful internal management decision process.p y g p
16
17. Effective communication of IC (6/10)( / )
6. Alignment of interests between company and investors
Progresses in the disclosure of IC may only be achieved by aligning the
interests of the company, asked to provide a higher quantity of better
lit i f ti t th t id ld d th i t h illquality information to the outside world, and the investor, who will use
this information within his or her valuation framework. Where true
alignment proves difficult, an adequate compromise should be aimed at.
One important issue to be covered is the disclosure/privacy balance
discussed above. Another relates to cost/benefit considerations, on the
sides of both the disclosing company and analysts/investors.
17
18. Effective communication of IC (7/10)( / )
7. Prevention of information overflow
Analysts and investors are confronted with a substantial stream of
information already today. Thus, while there is a clear lack of informationy y
on companies’ intellectual capital, this information should be focused
on the most crucial indicators.
Only then will analysts and investors be able to work with the additional
information on a day-to-day basis and closely integrate it into their
valuation frameworks Corporates should privilege relevance instead ofvaluation frameworks. Corporates should privilege relevance instead of
quantity also when publishing a separate Intellectual Capital Report.
18
19. Effective communication of IC (8/10)
8. Reliability and responsibility
As any reported company information information on IC should of course reflectAs any reported company information, information on IC should of course reflect
the true corporate situation. Both the choice of indicators and the calculation of
their values should be objective in portraying the company’s potential. Moreover,
the indicator values should be verifiable: it should be possible to track thethe indicator values should be verifiable: it should be possible to track the
sources of information in order to check accuracy (which also implies the
need for transparent indicator calculation methods, see principle 2).
On a more practical note, information on a company’s IC should be a true and
fair expression of its existing internal measurement system or the result of a
custom-made, transparent assessment process. The latter could be
conducted either internally or by third parties. In addition to external
assurance, the assignment of internal management responsibility (on board or
senior management level) for the information disclosed will be necessary.
19
20. Effective communication of IC (9/10)( / )
9. Risk assessment
Where feasible, disclosed information on a company’s IC should be
accompanied by an assessment of the risks inherent to each
indicator This should include those possible future events and theirindicator. This should include those possible future events and their
probability that might endanger a company’s operating performance.
For instance with reference to human capital this refers to the risk ofFor instance, with reference to human capital, this refers to the risk of
key employees leaving the firm. Risks are obviously higher when this
key personnel carries confidential and/or strategic knowledge. Another
important examples are risks to a company’s reputation.
20
21. Effective communication of IC (10/10)Effective communication of IC (10/10)
10. Effective disclosure placement and timing
Finally, information on a company’s IC should be communicated through both
efficient and effective channels, and with an adequate frequency. In our view, an
appropriate place for broader information on a company’s IC, as discussed in thispp p p p y ,
paper, would be the “Management Commentary” (or “Management Discussion and
Analysis”) within the annual report. Here, IC indicators can and should be embedded
in narrative where necessary to clarify their meaning and link to the company’s
future value creation. The publication of a separate Intellectual Capital Report is
another possibility, to be deliberated in the context of the company’s whole reporting
system.
Both ways would suggest a publication frequency synchronised with the annual
report. External stakeholders might ask to be provided with information on some
particularly important indicators of IC (or the associated risk assessments) more
frequently, though.
We would not rule out the notion of integrating broad information on IC into either the
balance sheet the profit and loss or the cashflow statements This being subject to
21
balance sheet, the profit and loss or the cashflow statements. This being subject to
valuation from accounting standard setters and a broader stakeholder community.
22. WICI – World Intellectual CapitalWICI – World Intellectual Capital
Initiative
Private/public sector collaboration aimed at improving capital
allocation through better corporate reporting information
P ti P ti f WICI Promoting Parties of WICI are:
Enhanced Business Reporting Consortium, which was founded by
American Institute of Certified Public Accountants, Grant
Thornton LLP Microsoft Corporation and PricewaterhouseCoopersThornton LLP, Microsoft Corporation and PricewaterhouseCoopers
European Federation of Financial Analysts Societies
Japanese Ministry of Economy, Trade and Industry
O i ti f E i C ti d D l t Organization for Economic Cooperation and Development
Society for Knowledge Economics
University of Ferrara
Waseda University
EC and BNDES as observers
http://www.wici‐global.com/p // g /
29. KPIs taxonomies for sectors
• Electronic components (WICI Japan)
Pharmaceutical (WICI Japan)• Pharmaceutical (WICI Japan)
• Automotive/automobile (WICI Japan)
T l i ti (WICI E EFFAS CIC)• Telecommunications (WICI Europe + EFFAS CIC)
• Software & IT services (EBRC + Gartner)
Mi i d E t ti (EBRC G t )• Mining and Extractive (EBRC + Gartner)
• Fashion & Luxury (WICI Europe +WICI Italy)
El t i it (WICI E WICI It l )• Electricity (WICI Europe + WICI Italy)
Available for free download in the WICI website Available for free download in the WICI website
(www.wici‐global.com)
30. C l i Th Q tiConclusions – Three Questions
• Are Luxembourg and its stakeholders willing to
participate in the identification and development of the
new measures and metrics (KPIs/KRIs) for the
Intangibles/Knowledge‐based Economy ?
• If yes, are Luxembourg stakeholders willing to join the
i t ti l i iti ti d t ib t t th iinternational initiatives and contribute to the ongoing
processes ?
• If yes, are Luxembourg stakeholders willing to set up
WICI Luxembourg – with the assistance of WICIWICI Luxembourg with the assistance of WICI
Europe – to foster and participate in these processes ?
31. Th k !Thank you !
For more information
WICI – Europe: zmbsfn@unife.it
WICI Luxembourg : anne laure mention@tudor lu WICI – Luxembourg : anne‐laure.mention@tudor.lu