Intangible Assets: Measurement, Drivers, and Usefulness

Intangible Assets: Measurement, Drivers, and Usefulness

Feng Gu (State University of New York at Buffalo, USA) and Baruch Lev (New York University, USA)
DOI: 10.4018/978-1-60960-071-6.ch007
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Abstract

This chapter develops an economic approach to estimating the value of intangible assets that are not recorded on the firm’s balance sheet. The authors demonstrate that their approach provides economically meaningful and useful estimates for the value of intangible assets. Their results indicate that investments in R&D, advertising, brands, and information technology are important drivers of intangible capital, and in turn corporate value. Their approach is shown to be useful to investors seeking information on future performance of intangible-intensive firms. They document evidence that the intangibles-based measures can effectively distinguish between overvalued and undervalued stocks. They believe the intangibles measures described here can add an essential, and hitherto missing, valuation tool for managers and investors concerned with intangible assets.
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Background

Intangible (knowledge) assets, such as new discoveries (drugs, software, etc.), brands or unique organizational designs (e.g., Internet-based supply chains), are nonphysically embedded sources of future benefits. The risk of intangible assets (e.g., drugs or software under development not making it to the market) is higher than that of physical assets.2 Accordingly, many, particularly accountants and corporate executives, are reluctant to recognize intangible capital as assets in financial reports, on par with physical and financial assets. Instead, most intangible expenditures are expensed, leaving the impression that these expenditures do not contribute to firm value. The lack of useful information significantly hinders the task of assessing the value of intangibles, particularly for investors who are outside the firm.3 Research finds that the information deficiency of intangible assets leads to large losses for investors, due to the information advantage of insiders (e.g., Aboody & Lev, 2000) and distorted and misleading accounting information (e.g., Lev, Sarath & Sougiannis, 2005).4 Managers also face significant difficulty in valuing the intangibles of target firms for acquisition as they frequently overpay for the intangibles of target firms in acquisition, such as goodwill, and bear the blame for subsequent goodwill write-off (Gu & Lev, 2009).5 Thus, managers also need more reliable approaches to valuing intangibles.

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