Abstract
The objective of the study is to examine the extent of disclosure of intellectual capital (IC) items, made by major Indian corporates indexed in Nifty 50, main index of National Stock Exchange (NSE). The sub-objective is examination of association if any, between the disclosure of IC by these corporates and factors such as sector, size, leverage, ownership structure, proportion of independent directors on board and profitability of the respective companies. The study discloses that a higher percentage of service sector companies have a high disclosure level as compared to industrial or other sector companies. The data reveal that company size and independence of the board (indicated by percentage independent directors) are positively associated and significant determinants of disclosure. The company size plays a more important role in influencing disclosure levels in industrial sector companies as compared to service sector. Companies with higher leverage and higher government ownership are likely to have lower disclosure indices. Intellectual capital disclosure (ICD) is not influenced by profitability of firms.
Introduction
Innovation and knowledge-led organizational strategies followed by firms have led to increased competition among firms of today. This competitive advantage is created through the strength of internal processes, organizational culture, knowledge sharing processes, efforts of employees, relationship with customers and their satisfaction such other similar assets. These assets termed as intellectual assets form the intellectual capital (IC) of firms.
Hansson (1997) opined that the drivers of value creation in modern competitive environment lie in a firm’s intellectual assets rather than in its physical and financial capital. Abeysekera (2006) observed that the focus of management is therefore shifting from tangible to intangible capital while considering ‘value creation’ processes in the firm. Past research has established that IC has an important role in creating value to the organizations (El-Bannany, 2008; White, Lee & Tower, 2007). It is therefore imperative that companies disclose more information about IC in their annual reports. This disclosure would help the firms achieve the objective of building a good reputation, gaining a competitive edge, increasing its market share, etc.
The evolution of intellectual capital research (ICR) over the past two decades has been categorized in three distinct stages by Guthrie, Ricceri and Dumay (2012). The first stage of ICR having origins in the late 1980s saw the development of a ‘framework of intellectual capital’. The main focus was on raising awareness of the importance of IC in ‘creating and managing sustainable competitive advantage’. The second stage of ICR was a stage where approaches to measuring, managing and reporting IC came to the front and gathered evidence in support of its further development. The third stage of ICR is emerging. This stage is characterized by research critically examining IC in practice with particular focus on the managerial implications of how to use IC in managing a company.
Observing the growing importance of IC across the world, it was considered appropriate to study the same in the Indian context. The corporate India has therefore been taken for study since it is a mix of knowledge-based industries as well as manufacturing industry.
This article focuses on the extent of disclosure of IC and its association with certain parameters related to the Indian companies forming part of the stock exchange index. It fills the gap in the literature of intellectual capital disclosure (ICD) since there is negligible study of ICD in India. The study is over the period 2014–2015 and the aim is achieved by:
Establishing the level of voluntary disclosure of IC made by the companies forming part of the National Stock Exchange’s (NSE) Nifty 50. Examining the association between the level of disclosure and certain factors that might affect the disclosure level.
The NSE is India’s leading stock exchange. The NSE was set up in November 1992, by leading institutions in order to provide a fully automated screen-based trading system. The NSE has performed the role of a catalyst in reforming the Indian securities market.
To capture the overall behaviour of the market, NSE has indices such as Nifty 50, Nifty Next 50, Nifty 100, Nifty 500 and many more. The Nifty 50 is a well-diversified 50 stock index accounting for 13 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index-based derivatives and index funds. The Nifty 50 Index represents about 66.17 per cent of the free float market capitalization of the stocks listed on NSE as on 31 March 2015. The total traded value of Nifty 50 index constituents for the last 6 months ending March 2015 is approximately 46.22 per cent of the traded value of all stocks on the NSE.
The structure of this article is as follows. The second section provides the literature review. The third section thereafter, outlines the objectives of the study describing the variables chosen for the study that might affect the level of disclosure. The fourth section gives the rationale of the study. The fifth section states the research methodology followed by the sixth section which discusses the empirical evidence on the relationship between ICD and independent variables. The seventh section presents the conclusions followed by limitations in the eighth section.
Literature Review
Intellectual capital being a relatively new concept, has been defined differently by different researchers. According to Petty and Guthrie (2000), the term ‘intellectual capital’ has interchangeably be used with ‘intangibles’, ‘intangible assets’ or ‘knowledge resources’. Table 1 lists few of the definitions proposed by scholars.
Sveiby (2004) classified IC into three broad areas of intangibles, namely, human capital, structural capital and customer capital, which was later modified by replacing customer capital by relational capital.
Research on IC and its disclosure has observed a gradual growth in case of corporate and banks across developed and developing nations. These studies have very often examined the status of IC disclosure with respect to a particular country (usually cross-sectional) or with regard to a specific industrial sector (or an organization) through a selection of top listed companies on country’s stock exchange.
A number of studies undertaken by researchers across countries to investigate the level of IC disclosure in national context observed that there is absence of an established framework for IC reporting as also that the level of IC disclosure is generally low with regard to most IC items. These studies either employed Guthrie and Petty’s framework or modified it to suit their needs. Examples comprise Bontis (2003, Canada), Goh and Lim (2004, Malaysia), Abeysekera and Guthrie (2005, Sri Lanka), Guthrie, Petty and Ricceri (2006, Hong Kong), Ensslin and De Carvalho (2007, Brazil), Yi and Davey (2010, China), etc.
Some studies have been conducted with regard to specific industry. Most often, the Banking industry has been the subject of research for studying the level of IC disclosure (El-Bannany, 2008, 2013; Haji & Mubarak, 2012; Khan & Ali, 2010).
Some researchers have attempted to develop a comprehensive IC disclosure index for content analysis of corporate annual reports. These include Shareef and Davey (2005), Schneider and Samkin (2008) and Yi and Davey (2010). These indices are considered to be helpful to assess not only the extent but also the quality of IC disclosure.
There is presence of research literature which shows that some studies were undertaken to compare IC disclosure practices across different countries. These include studies undertaken by Vandemaele, Vergauwen and Smits (2005, Sweden, Netherlands and UK), Guthrie et al. (2006, Australia and Hong Kong) and Abeysekera (2008, Singapore and Sri Lanka). This type of research resulted in a better understanding of IC disclosure practices in an international context.
Some researchers attempted to study the trend of IC disclosure in a particular country or industry by undertaking a longitudinal research. Such researchers include Williams (2001), Bruggen, Vergauwen and Dao (2009) and Campbell and Rahman (2010). They analysed the annual report of sample companies for several years (usually from 2 years to 5 years). However, longitudinal study of IC disclosure is quite limited and needs to be undertaken in the future research.
Definitions of Intellectual Capital
There are also a few studies where researchers have made an attempt to examine the factors that determine the level of IC disclosure in a particular country or industry (e.g., García-Meca, Parra, Larran & Martinez, 2005; Li, Pike & Haniffa, 2008; White et al., 2007; Whiting & Woodcock, 2011). These studies usually applied a quantitative approach in which a series of hypotheses were developed to test the correlations between IC disclosure and a number of impact factors industry type, size of company, listing status, profitability, level of leverage, structure of ownership, proportion of independent directors, type of auditor and others.
It is noted that the most prior research regarding IC disclosure focuses on developed countries and very few on developing countries (Abeysekera & Guthrie, 2005; Ensslin & De Carvalho, 2007; Kamath, 2008; Singh & Kansal, 2011; Yi & Davey, 2010).
Research on IC and its disclosure in the context of India is truly in its nascent stage. Very few studies have been carried out in this area. Studies include research conducted by Vishnu and Gupta (2014, pharmaceutical sector), Bhatia and Mehrotra (2015, Banking), Mondal and Ghosh (2012, Banking), Joshi, Ubha and Sidhu (2011, IT firms), Bhasin (2011, IT firms) and Kamath (2008, Technology, entertainment, communication and other knowledge companies). A common observation made by these researchers was that IC disclosure was significantly low by Indian firms.
The study of Joshi, Ubha and Sidhu (2012) identified IC disclosure differences between Indian and Australian firms and observed that disclosures by Indian companies were more than Australian Software and Technology Sector companies. However, level of voluntary IC disclosure was found to be low in both the nations and most of the disclosures were declarative in nature.
This study attempted to provide an insight into the narrative style of IC disclosures done by the Indian corporations.
Objectives
The main objective of this article is to study the extent of disclosure of IC by leading Indian companies in their annual reports.
Past research has shown some factors as being determinants of a company’s ICD level (El-Bannany, 2008; White et al., 2007). This article examines factors like sector to which the company belongs (service or industrial), size (in terms of total assets), leverage (long-term debt to total assets), ownership structure (government owned or otherwise), independence of board (per cent of independent directors) and profitability (proportion of net profit before tax to total assets. These factors will now be considered and examined.
Type of Sector
There exists an indication in past studies that the type of sector to which the company belongs, impacts the level of ICD due to varied competitive and political costs across industries (Guthrie & Petty, 2000; Oliveira, Rodrigues, & Craig, 2006). On the contrary, García-Meca et al. (2005) found that industry was not a significant factor in determining the level of IC disclosure. This study attempted to examine whether type of sector to which the company belongs has any influence on the disclosure level of IC in India. Accordingly, the sample companies were categorized under two industry groups: the service group and the industrial group. All companies in sectors or industries, such as finance, services and utilities formed the ‘service group’, which are normally rich in IC. The industrial group comprised of companies in the energy, material and industrial/consumer goods sectors, which are normally rich in tangibles.
Size
Past researchers have suggested that size of the company is an important factor which has a positive impact on the level of disclosure of IC by companies (for instance, El-Bannany, 2013; García-Meca et al., 2005; Kamath, 2008; Li et al., 2008). It has been argued that large companies have a higher disclosure level as compared to small companies as they are able to absorb the cost of preparing information for disclosure, have better internal systems and management information systems and are under pressure to exercise social responsibility (see for example García-Meca et al., 2005).
In the absence of any scientific theoretical basis to measure the size of a company, total assets, revenues or market capitalization are often used to indicate the size of firms. In the present study, revenue has been used as a measure of firm size as it is not affected by accounting standards. Based on this argument, the present study examined whether there is a positive relationship between size of the company and ICD level.
Leverage
The extent of leverage of a firm is considered to be an important factor for determining the disclosure level. White, Lee, Yuningsih, Nielsen and Bukh (2010) suggested that firms willing to take more debt, face the pressure of disclosure in regard to the global reporting practices. However, García-Meca et al. (2005) and Oliveira et al. (2006) did not find any statistically significant relationship between a firm’s leverage and its level of IC disclosure. In the prior studies, the ratio of book value of total debt to book value of total assets has often been employed as an indicator for the level of leverage. The present research adopted this ratio as a proxy for leverage of firms and studied the existence of a relationship between a company’s leverage and ICD.
Ownership Structure
Studies conducted in the past have evidenced a significant association between Government ownership and corporate disclosures (Said, Zainuddin & Haron, 2009). However, Mohd Ghazali and Weetman (2006) found insignificant association between government ownership and Corporate Voluntary Disclosures (CVDs). Companies with wide shareholding pattern can be expected to voluntarily report more information so as to reduce asymmetry of information and thereby the related agency costs (Oliveira et al., 2006). Since government ownership plays an important role in many of the indexed firms in India, the level of ownership concentration is measured by percentage of government ownership. The present study expects that public sector companies having government as the major shareholder would disclose less information.
Independence of Board
The level of board independence influences a firm’s decision to voluntarily disclose information. Past studies, such as White et al. (2007) and Li et al. (2008), evidenced a statistically significant positive relationship between the level of board independence and the level of IC disclosure. As a proxy for board independence, the proportion of independent directors on board to the total number of directors on the board is normally employed.
Independent directors are individuals who do not have any management roles or links with the firm. They represent shareholders to monitor activities of the company. Using their expertise and professional reputation, they are capable of influencing the disclosure policy of a company (Li et al., 2008; White et al., 2007). In accordance with Li et al. (2008), the more number of independent directors on the board, would push managers to have a more proactive disclosure policy. This study examined whether there exists a positive relationship between proportion of independent directors on board and ICD.
Profitability
Profitability is a key measure of corporate performance. Prior studies have considered it as another determinant factor for voluntary ICD. García-Meca et al. (2005) and Li et al. (2008) observed a statistically significant positive association between profitability of a firm and its ICD. However, Sonnier, Carson and Carson (2007) obtained a different result. Net profit or return on total assets (ROA) was often used as a proxy for profitability in the past studies. In the current study, ROA (net profit before taxation/book value of total assets) was adopted to examine the association between profitability and the level of IC disclosure.
Rationale for the Study
With the growing importance of IC across the world, it is imperative that the same is studied in the Indian context as well. However, the literature available on ICD in India is very limited in the context of corporate sector in India. The present study fills the gap in the literature of ICD as there is absence of prior study of ICD by Indian companies, which examines the extent of disclosure of IC and the relationship between ICD and the various factors.
Research Methodology
This section discusses the process of sample selection and data collection.
Sample Selection
The study is based on collection of secondary data of companies which are listed on NSE and form part of its main index Nifty 50. All 50 companies in the said index have been included in the study. They comprise of both public and private sector companies. The constituents of the sample are given in Tables 2 and 3.
Constituents of the Sample
Constituents of the Sample
Scoring of the Disclosure Index
Annual reports are a tool in the hands of the management to signal important issues. This is the reason for selecting the annual reports as a source of information for IC research. Many prior studies on IC disclosures have used content analysis as a tool (Cordazzo, 2007; Haji & Mubarak, 2012).
This research adopts the framework for IC items developed by Sveiby (1997, pp. 8–11) given in Table 4.
For calculation of the Disclosure score, each firm is given a score of 1 for item disclosed and a score of zero for item not disclosed. Disclosure index is calculated by dividing the number of items disclosed by the total items measured, that is, 21.
Disclosure score =
Where,
d = 1 if the ratio is disclosed and 0 if it is not
n = number of items
The extent of the IC disclosure index is quantified using the following formula:
where di expresses item i when the item’s value is 1 with disclosure and 0 when there was no disclosure, and M is 21 (the total number of items being measured).
Framework for IC items by Sveiby
Regression Model
The study uses multiple regression analysis to study the association between IC disclosure level and its potential indicators (Table 5). The following regression model is used to evaluate the association:
Results and Discussions
Statistical Analysis
Extent of disclosure
We performed a simple visual descriptive analysis and found from Figures 1–3 that in terms of internal capital most companies disclose management philosophy and processes but few will disclose patents, copyrights, culture and financial relations. In terms of external capital most companies disclose the most about customer loyalty, market share, brand and collaborations. Employee training is the most disclosed human capital indicator.
Disclosure Index
In Table 6, we used the disclosure index tertiles to classify a company as having low, medium or high level of ICD. Companies with disclosure index below the 33rd percentile are classified as low disclosure, those between 33rd and 66th percentiles are classified as medium disclosure and disclosure index greater than 99th percentile are regarded as high level of disclosure.
Description of Dependent and Independent Variables Measured and Analysed During the Course of This Study
To investigate if there is a relationship between sector and disclosure status, we performed a chi-square test (Table 7). The test indicated a statistically non-significant (p-value = 0.1442) relationship, and we found that in the industrial sector companies, disclosure levels are mostly low (41.94 per cent), whereas in the service disclosure levels are mostly high (52.63 per cent).
We performed an independent sample t-test to test whether service sector has higher average disclosure than industrial sector. The null hypothesis is that there is no difference in mean disclosure index between the two sectors versus the alternative that service sector mean disclosure is greater than industrial sector. The test statistic value t = −1.7305 with 48 degrees of freedom gives a p-value of p = 0.045. This indicates that service sector mean is slightly significantly greater than industrial sector disclosure index mean.
Classification of Companies by Disclosure Index Tertiles
Chi-square Test
Determinants of intellectual capital disclosure
A non-parametric correlation analysis (Table 8) was first done to assess the strength and direction of the relationship between disclosure index and the independent variables. We can see that company size and independent directors are positively and significantly correlated. Leverage and ownership structure are negatively correlated but the strength of the relationship is very weak.
Correlation Analysis
In simple regression analysis (Table 9) with disclosure index as outcome and each of independent variables separately, we found company size and independent directors to be statistically significant. The R2 values indicate that company size explains 7.7 per cent of the variation in disclosure index, whereas independent directors although significant (p-value = 0.040) explains 5.6 per cent of the variation in disclosure index.
In a multiple regression analysis (Table 10) when we adjusted for other variables, company size was statistically significant (p-value = 0.012) but independent directors were non-significant (p-value = 0.199). We also observed that after including all independent variables in the model, the adjusted R-square changes (15 per cent). When we segregated the regression analysis by sector (Table 11), we found that company size was a significant determinant of disclosure after adjusting for other independent variables in the analysis for the industrial sector companies but not for service sector. The adjusted R2 value for the sector-wise disclosure models also improved significantly.
Simple Linear Regression
Multiple Regression Analysis
Multiple Regression Analysis Segregated by Sector
Conclusion
The descriptive analysis indicates that disclosure of IC in our sample is lower in the industrial sector companies as compared to service sector companies. Our inferential analysis, however, indicates that there is no significant relationship between sector and level of disclosure. So whether a company belongs to industrial or services sector they are likely to have the same level of ICD. Out of a predetermined list of 21 IC items under three main categories of Internal, external and human capital, the item most disclosed by companies is ‘extent of employee training’ (human capital category) which was disclosed by 49 companies out of 50 indexed companies, closely followed by ‘customers’ (external capital category) and ‘business collaboration’ (external capital category) which were disclosed by 48 and 47 companies, respectively. ‘Management philosophy’ (internal capital category) was the next most disclosed item, disclosed by 44 companies.
There was no information on ‘management culture’ (internal capital category), ‘reputation for services’ (external capital category) and ‘entrepreneurial spirit’ (human capital category) in any of the annual reports of the companies. Only one firm disclosed information on ‘copyright’ (internal capital) and ‘customer loyalty’ (external capital). On one of the extreme sides, is a company with 80.95 per cent disclosure level and on the other is a company having as low as a disclosure level of 19.05 per cent. In terms of ICD, a higher percentage of service sector companies have a high disclosure level as compared to industrial or other sector companies. The data reveal that company size and percentage of independent directors are positively associated and significant determinants of disclosure. The role of company size as an indicator of disclosure is more significant in industrial sector companies as compared to service sector. Companies with higher leverage and higher government ownership structure scores are likely to have lower disclosure indices.
Vast differences are observed in items disclosed and overall ICD in companies. Securities Exchange Board of India being the regulator, may like to introduce guidelines to improve disclosure levels of IC by companies. This would help in reducing information asymmetry between insiders and other stakeholders as also make capital markets more efficient.
Limitations
There are limitations of this study. First, more evidence is required on the determinants of ICD before any generalization of the results can be made. Second, this study is on large cap companies only and for a specific year. Future research study should be longitudinal and seek to broaden the current sample to other countries and/or sectors. Third, a predetermined ICD framework was used in the current study. Future research should seek to devise a framework for IC disclosures. Fourth, content analysis of only the annual reports was conducted for this study. Other sources of information on IC, such as website, initial public offering prospectus, brochures, and employee handbook, should also be studied.
Footnotes
Acknowledgements
The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve the quality of the article. Usual disclaimers apply.