Intangible Values in Financial Accounting and Reporting An Analysis from the Perspective of Financial Analysts

Foreword V Even though intangible values have continuously become significant value drivers of companies in today’s economy, financial accounting and reporting still lacks to properly in

Intangible Values in Financial Accounting and Reporting

An Analysis from the Perspective of Financial Analysts

D I S S E R T A T I O N

of the University of St Gallen, School of Management, Economics, Law, Social Sciences and International Affairs

to obtain the title of Doctor of Philosophy in Management

submitted by

Stephan Grüber

from Germany

Approved on the application of

Prof Dr Peter Leibfried

and

Prof Dr Dirk Schäfer

Dissertation no 4274 Springer Gabler, Wiesbaden 2014

Sciences and International Affairs hereby consents to the printing of the present dissertation, without hereby expressing any opinion on the views herein expressed

St Gallen, May 19, 2014

The President:

Prof Dr Thomas Bieger

Intangible Values in Financial Accounting and Reporting

Stephan Grüber

Intangible Values in Financial Accounting and Reporting

An Analysis from the Perspective

of Financial Analysts

With a Foreword by Prof Dr Peter Leibfried

St Gallen, Switzerland

Dissertation, University of St Gallen, Switzerland

ISBN 978-3-658-06549-2 ISBN 978-3-658-06550-8 (eBook)DOI 10.1007/978-3-658-06550-8

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Foreword V

Even though intangible values have continuously become significant value drivers of companies in today’s economy, financial accounting and reporting still lacks to properly incorporate and to report such values Despite the ongoing debate throughout the past decades, a universal solution inside or outside of the traditional information means has not yet been developed As a consequence, financial accounting and reporting still provides an incomplete picture of an entity’s true resources and claims While it is necessary to acknowledge that financial accounting and reporting has inherent limitations and is not supposed to present absolute data, further analysis is required to better understand and to potentially close the information gap In this thesis, Stephan Grüber focuses on the information use of financial analysts, one of the primary users of IFRSs He investigates how financial analysts utilize and incorporate information on intangible values in their decision-making processes and whether such information influences decisions In addition, the study examines the preferences of financial analysts in regard to accounting for and reporting intangibles in the future Upon outlining the fundamentals of financial accounting and reporting, Stephan examines the foundations and challenges of intangible values and provides an overview of concepts introduced to improve the accounting and reporting of intangibles As a next step, he distinguishes various groups of financial analysts and their decision-making objectives, such as buy- and sell-side analysts and equity and fixed income analysts Chapter 5 represents the main body of this thesis, presenting and discussing two empirical studies The first part describes the results of a content analysis of sell-side research reports, offering insights into the information use of sell-side analysts The second part analyzes the results of a web-based experimental survey with over 1,100 financial analysts, focusing on the importance of information of intangibles for their decision-making

The present analysis offers detailed and comprehensive evidence on the actual information use and preferences of financial analysts, contributing to an improved understanding of the user perspective in financial accounting and reporting, i.e what users effectively require with respect to information on intangible values Hence, this thesis may not only be valuable to individuals in academia, but is also useful for

practitioners and executives focusing on corporate communication In addition, the results may further provide financial analysts with stimulating self-insight regarding their decision-making I therefore wish this thesis to be widely read and accepted by a broad audience

St Gallen, June 2014

Prof Dr Peter Leibfried, CPA, MBA

Managing Director of the Institute of Accounting, Control and Auditing (ACA-HSG)

at the University of St.Gallen and doctoral advisor of Stephan Grüber

Acknowledgements VII

The present thesis is the result of my Ph.D studies at the University of St Gallen (HSG) in Switzerland It was submitted and approved to obtain the title Doctor of Philosophy in Management

Throughout the course of my studies, there has been much support from many different people and I would like to take this opportunity to thank all of them First and foremost, I am particularly indebted to my doctoral advisor, Prof Dr Peter Leibfried, who made this research possible, continuously providing me with guidance and encouragement over many years His insights and advice significantly helped me to complete this work I would further like to express my sincere gratitude to Prof Dr Dirk Schäfer, who served as co-advisor and supported this project with valuable thoughts and ideas

I have written this thesis while being a full-time employee at KPMG LLP in New York In order to participate in the Ph.D program in St Gallen and to draft my thesis I was granted several study leaves I would therefore like to express my genuine thanks

to Dr Norbert Fischer and Jan Storbeck for their trust and flexibility Moreover, I also thank Ingo Zielhoff, who supported me during the final phase of this project

I would also like to specifically thank Dr Torsten Jaskolski for discussing and exchanging our ideas throughout the years Special thanks go to Nicholas Jungovic for supporting me and reading the draft of this thesis In addition, I further extend my thanks to my family and friends, who have always been there for me despite my limited time

My deepest gratitude goes to my love Sophie for her unbounded patience, understanding and sacrifices along the way, as well as for her motivating and encouraging words during difficult times Last but not least, I would also like to extend

my appreciation and thanks to my parents for their love and unconditional support This thesis is dedicated to them – it would not have been possible without them

Brief Contents IX

1 I NTRODUCTION .1

Relevance and Motivation of this Study 1

1.1 Purpose and Methodology of this Study 3

1.2 2 T HE F UNDAMENTALS OF F INANCIAL A CCOUNTING AND R EPORTING .7

2.1 Introduction to the Chapter 7

2.2 Justification for the Existence of Financial Accounting and Reporting 7

2.3 Principles of Capital Markets-Oriented Financial Accounting and Reporting 24

2.4 Preliminary Summary 33

3 F OUNDATION AND C HALLENGES OF I NTANGIBLE V ALUES IN F INANCIAL A CCOUNTING AND R EPORTING 35

3.1 Introduction to the Chapter 35

3.2 Characteristics and Attributes of Intangibles 35

3.3 Intangibles and International Financial Reporting Standards 52

3.4 Concepts to Improve Financial Accounting and Reporting of Intangible Values 82

3.5 Consequences for the Further Analysis 108

4 F INANCIAL A NALYSTS AS U SERS OF F INANCIAL A CCOUNTING AND R EPORTING I NFORMATION 110

4.1 Introduction to the Chapter 110

4.2 Fundamentals of Financial Analysts 111

4.3 The Elements of Financial Analysts’ Decision-Making 131

4.4 Financial Analysts and Information on Intangible Values 145

4.5 Summary and Implications for this Study 163

5 E MPIRICAL A NALYSES OF THE P ERSPECTIVE OF F INANCIAL A NALYSTS ON I NFORMATION ABOUT I NTANGIBLES 166

5.1 Introduction to the Chapter 166

5.2 Content-Analysis of Sell-Side Research Reports 169

5.3 Experimental Survey 274

5.4 Limitations of the Selected Methodologies 399

6 S UMMARY AND C ONSEQUENCES FOR R EPORTING I NTANGIBLE V ALUES 401

6.1 Introduction to the Chapter 401

6.2 Summary and Implications of the Findings 401

6.3 Recommendations for Accounting and Reporting Intangible Values 408

6.4 Future Prospects 411

2 T HE F UNDAMENTALS OF F INANCIAL A CCOUNTING AND R EPORTING .7

Introduction to the Chapter 7 2.1.

Justification for the Existence of Financial Accounting and Reporting 7 2.2.

2.2.1 Neoclassical Economic and Finance Theory 8

The Efficient-Market Hypothesis and Empirical Evidence 9 2.2.1.1

Implications of the Efficient-Market Hypothesis 11 2.2.1.2

2.2.2 New Institutional Economics and Principal Agent Theory 14

Information Asymmetries and Agency Costs 16 2.2.2.1

Financial Information as a Solution to the Agency Problem 18 2.2.2.2

2.2.3 Summary and Consequences for the Design of Financial Accounting and Reporting 21

Principles of Capital Markets-Oriented Financial Accounting and 2.3.

Reporting 24

2.3.1 Primary User Group and Objectives of International Financial

Reporting Standards 24 2.3.2 Definition and Criteria of Decision-Useful Information 28

Preliminary Summary 33 2.4.

3 F OUNDATION AND C HALLENGES OF I NTANGIBLE V ALUES IN F INANCIAL

A CCOUNTING AND R EPORTING 35

Introduction to the Chapter 35

3.1 Characteristics and Attributes of Intangibles 35

3.2. 3.2.1 Definition and Distinction of Intangibles 36

3.2.2 Economic Properties of Intangible Values 40

3.2.3 Classification of Intangible Values 45

Legal Classification Scheme 45

3.2.3.1 Economic Classification Schemes 47

3.2.3.2 Intangibles and International Financial Reporting Standards 52

3.3. 3.3.1 Initial Recognition and Measurement of Intangible Assets 53

Definition of Intangible Assets 55

3.3.1.1 Recognition and Measurement of Intangible Assets 63

3.3.1.2 Acquisition as Part of a Business Combination 65

3.3.1.3 Additional Requirements for Internally Generated Intangibles 68

3.3.1.4 3.3.2 Subsequent Measurement 72

3.3.3 Current Disclosure Requirements for Intangible Assets 73

3.3.4 Constraints and their Impact 74

Decreasing Relevance of IFRSs and It Reasons 74

3.3.4.1 Impact of Failing to Provide Information on Intangible Values 77

3.3.4.2 Concepts to Improve Financial Accounting and Reporting of 3.4 Intangible Values 82

3.4.1 Extended Reporting within the Classic Presentation Formats 82

The AASB Discussion Paper 83

3.4.1.1 Additional Proposals 87

3.4.1.2 3.4.2 Proposals for an Extended Business Reporting of Intangible Values 89

Top-Down Methods of an Extended Business Reporting 93

3.4.2.1 Bottom-Up Methods of an Extended Business Reporting 100

3.4.2.2 Consequences for the Further Analysis 108

3.5 4 F INANCIAL A NALYSTS AS U SERS OF F INANCIAL A CCOUNTING AND R EPORTING I NFORMATION 110

Introduction to the Chapter 110

4.1 Fundamentals of Financial Analysts 111

4.2. 4.2.1 Definition and Responsibilities of Financial Analysts 111

4.2.2 Classification and Different Types of Financial Analysts 115

Institutional Classification 115

4.2.2.1 Functional Classification 120 4.2.2.2

Table of Contents XIII

4.2.3 Financial Analysts as Providers of Useful Information 126

The Elements of Financial Analysts’ Decision-Making 131

4.3. 4.3.1 Collecting Information 132

4.3.2 Information Processing 136

Equity Financial Analysts 137

4.3.2.1 Fixed Income Financial Analysts 140

4.3.2.2 4.3.3 Distribution of Information 144

Financial Analysts and Information on Intangible Values 145

4.4. 4.4.1 Methods Employed by Equity Analysts 145

Technical Analysis 146

4.4.1.1 Fundamental Analysis 147

4.4.1.2 Additional Valuation Models 155

4.4.1.3 4.4.2 Methods Employed by Fixed Income Analysts 156

4.4.3 Behavioral Aspects 159

Decision-Making Concepts 159

4.4.3.1 Behavioral Influences 160

4.4.3.2 4.4.4 Other Aspects 163

Summary and Implications for this Study 163

4.5 5 E MPIRICAL A NALYSES OF THE P ERSPECTIVE OF F INANCIAL A NALYSTS ON I NFORMATION ABOUT I NTANGIBLES 166

Introduction to the Chapter 166

5.1 Content-Analysis of Sell-Side Research Reports 169

5.2. 5.2.1 Purpose of this Content Analysis 169

5.2.2 General Objectives and Methodology of Content Analysis 170

5.2.3 Prior Content Analyses in Accounting Research 174

5.2.4 Research Gap and Hypotheses for this Study 184

5.2.5 Research Design of this Study 191

Description of the Research Object 191

5.2.5.1 Sample Selection and Data Collection 195

5.2.5.2 Test Procedures and Constructing the Intangible Score 196

5.2.5.3 Applied Statistical Tests 203

5.2.5.4 5.2.6 Validity and Reliability of the Content Analysis 209

5.2.7 Findings and Discussion 213

Descriptive Statistics of the Sample 214

5.2.7.1 Preferred Valuation Methods 219

5.2.7.2 Results for the Total Sample 221

5.2.7.3 5.2.7.3.1 Human Capital Information Items 225

5.2.7.3.2 Internal Capital Information Items 231

5.2.7.3.3 External Capital Information Items 241

Results for the Hypotheses Tests 246

5.2.7.4 5.2.7.4.1 Report Characteristics 246

5.2.7.4.2 Firm Characteristics 253

5.2.8 Preliminary Summary 271

Experimental Survey 274

5.3. 5.3.1 Objectives of the Survey 274

5.3.2 Sample and Data Collection Procedures 276

5.3.3 Survey Structure and Applied Statistical Tests 279

Investment Recommendation Task 280

5.3.3.1 5.3.3.1.1 The General Framework of Conjoint Analysis 281

5.3.3.1.2 Conjoint Analysis in Accounting and Finance Research 295

5.3.3.1.3 Design of the Investment Recommendation Task 304

Design and Approach Related to Other Investigated Variables 311

5.3.3.2 5.3.4 Response Rate and External Validity 313

5.3.5 Findings and Discussion 320

Descriptive Statistics of Respondents 321

5.3.5.1 Preferred Information Sources 326

5.3.5.2 5.3.5.2.1 Results for the Total Sample 327

5.3.5.2.2 Comparisons of Analyst Groups 330

5.3.5.2.3 Additional Information Sources Mentioned by Financial Analysts 336

Valuation Methods of Financial Analysts 337

5.3.5.3 5.3.5.3.1 Results for the Total Sample 338

5.3.5.3.2 Comparisons of Analyst Groups 340

5.3.5.3.3 Additional Valuation Methods Mentioned by Analysts 343

Perceived Importance of Inputs for Company Valuation and 5.3.5.4 Analysis 345

5.3.5.4.1 Results for the Total Sample 346

5.3.5.4.2 Comparisons of Analyst Groups 351

5.3.5.4.3 Additional Valuation Inputs Mentioned by Financial Analysts 358

Investment Recommendation Task 360

5.3.5.5 5.3.5.5.1 Results for the Total Sample 361

5.3.5.5.2 Comparison of Different Analyst Groups 372

Preferences about Reporting Information on Intangibles 378

5.3.5.6 5.3.5.6.1 Results for the Total Sample 379

5.3.5.6.2 Comparison of Analyst Groups 385

5.3.5.6.3 Additional Comments Mentioned by Financial Analysts 394

Table of Contents XV

5.3.6 Preliminary Summary 397

Limitations of the Selected Methodologies 399

5.4 6 S UMMARY AND C ONSEQUENCES FOR R EPORTING I NTANGIBLE V ALUES 401

Introduction to the Chapter 401

6.1 Summary and Implications of the Findings 401

6.2 Recommendations for Accounting and Reporting Intangible Values 408

6.3 Future Prospects 411

6.4 A PPENDIX 415

I NDEX OF A CCOUNTING P RINCIPLES , S TANDARDS AND OTHER S TATUTES 485

I NDEX OF S ELL -S IDE R ESEARCH R EPORTS CITED IN THE M AIN T EXT 487

R EFERENCES 491

Upon defining and characterizing intangible values, the current state of IFRSs with respect to such values is discussed, highlighting the associated issues, the impacts and the proposals to overcome the current state Subsequently, the fundamentals of financial analysts are introduced, including their objectives, their potential classification schemes as well as their decision-making processes

The main part of this thesis reports on two empirical studies that were carried out to examine the actual information use of financial analysts The first study applied the method of content analysis to sell-side research reports, finding evidence for the use of information on intangible values by sell-side analysts The second study employed survey methodology to investigate the perceptions of four different analysts groups on intangible values The second study further included an experimental part that allowed observing data derived from actual decisions

In summary, it was found that information on intangible values is useful for the decisions of the different analyst groups Moreover, the user needs and preferences were discussed in order to define several recommendations of how to report information on intangible values

In den letzten Jahren wurde immer wieder vorgebracht, dass immaterielle Werte zunehmend die bedeutenden Werttreiber in den Unternehmen der heutigen Zeit darstellen Wichtige Produktionsfaktoren sind nicht mehr materielle Vermögenswerte, sondern vielmehr Marken, Wissen oder anderweitige technologische Innovationen Basierend auf dieser Annahme, wird die Aussage getroffen, dass die Informationen über solche Phänomene in den Allokationsentscheidungen der Kapitalgeber einer Unternehmung unerlässlich sind

Die vorliegende Arbeit untersucht die Informationsverwendung durch Finanzanalysten und deren Informationsbedürfnisse in Bezug auf immaterielle Werte Zweck der Arbeit ist es, den Nutzen solcher Informationen aus der Perspektive von einer der primären Adressatengruppe von IFRS näher zu beleuchten

Nach der Begriffsabgrenzung des immateriellen Werts, werden zunächst die aktuellen Regelungen der IFRS dargestellt sowie problematisiert und die in der Literatur diskutierten Lösungsvorschläge präsentiert Im Anschluss werden die Grundlagen der Finanzanalysten in Bezug zu ihren Zielen, möglichen Klassifizierungen und Entscheidungsprozessen dargestellt

Im Hauptteil dieser Arbeit werden zwei empirische Studien vorgestellt, die die tatsächliche Verarbeitung von Informationen durch Finanzanalysten untersucht haben Die erste Studie hat unter Verwendung der Inhaltsanalysetechnik Sell-Side-Research-Berichte auf die Verwendung von Information bezüglich immaterieller Werte hin untersucht Die zweite Studie nutzte Survey-Methodik, um die Wahrnehmung von Finanzanalysten in Bezug auf immaterielle Werte zu untersuchen Die zweite Studie beinhaltete zusätzlich einen experimentellen Teil

Zusammenfassend wurde festgestellt, dass Informationen über immaterielle Werte nützlich für die Entscheidungen von Finanzanalysten sind Zusätzlich wurden die Bedürfnisse und Präferenzen der Analysten diskutiert, um Empfehlungen zur Berichterstattung über immaterielle Werte geben zu können

List of Abbreviations XIX

AFAANZ Accounting & Finance Association of Australia and New Zealand AICPA American Institute of Certified Public Accountants

Asymp Asymptotic

BFuP Betriebswirtschaftliche Forschung und Praxis (Journal)

Cf Confer

DDM Dividend Discount Model

EBITDA Earnings Before Interest, Tax, Depreciation and Amortization

EMH Efficient-Markets-Hypothesis

et seq and the following (singular)

EUR Euro

fn footnote

FTSE-100 Financial Times Stock Exchange (British Stock Index)

H Hypothesis

List of Abbreviations XXI

IFASS International Forum of Accounting Standard Setters

IFRIC International Financial Reporting Interpretations Committee IFRS(s) International Financial Reporting Standard(s)

IOSCO International Organization of Securities Commissions

IRZ Zeitschrift für Internationale Rechnungslegung (Journal)

KGaA Kommanditgesellschaft auf Aktien (German Partnership limited by

Shares) KoR Zeitschrift für internationale und kapitalmarktorientierte

Rechnungslegung (Journal)

LINMAP Linear Programming Techniques for Multidimensional Analysis of

Preference

m Million(s)

MERITUM Measuring Intangibles to Understand and Improve Innovation

Management

No Number

OLS (Method of) Ordinary Least Squares

PRISM Policy-Making – Reporting and Measurement – Intangibles –

Skills Development – Management (EU Project)

REG regulation

RICARDIS Reporting Intellectual Capital to Augment Research, Development

and Innovation in SMEs (EU Project)

SPSS Statistical Package for the Social Sciences (Software Application)

List of Abbreviations XXIII

Std standard

STRAT Strategy

vol volume

vs versus

ZfbF Zeitschrift für betriebswirtschaftliche Forschung (Journal)

ZfCM Zeitschrift für Controlling & Management (Journal)

List of Figures XXV

Figure 1: Structure of this Thesis 6 Figure 2: Economic Reasons and the Information Function 24 Figure 3: Primary User Group and their Decision-Making Objectives 27 Figure 4: Qualitative Characteristics of Useful Financial Information 30 Figure 5: Value Drivers vs Value Distractors of Intangibles 42 Figure 6: Legal Classification Scheme 47 Figure 7: Recognition of Intangible Assets According to IAS 38 71 Figure 8: Approaches to an Extended Business Reporting 93 Figure 9: Intangible Asset Statement 99 Figure 10: Balanced Scorecard 101 Figure 11: Framework of the Skandia Navigator 102 Figure 12: Intangible Asset Monitor 105 Figure 13: Value Chain Scoreboard 107 Figure 14: Objectives and Functions of Analysts and Security Analysis 113 Figure 15: Functional Areas of Research 120 Figure 16: Information Channeling by Financial Analysts 128 Figure 17: Extended Information Channeling by Financial Analysts 192 Figure 18: Classification Scheme of the Coding Instrument 199 Figure 19: Frequency Distribution of Reports by Bank 214 Figure 20: Frequency Distribution of Reports by Years 215 Figure 21: Frequency Distribution of Reports by Recommendation Type 216 Figure 22: Frequency Distribution of Reports by Industry 217 Figure 23: Preferred Valuation Methods (Content Analysis) 220 Figure 24: Mean Occurrences of Sub-Category Scores (Total Sample) 224

Figure 25: Mean Occurrence of Sub-Category Scores (Recommendation) 248 Figure 26: Mean Occurrences of Sub-Category Scores (Pre- and Post-Peak) 252 Figure 27: Mean Occurrences of Sub-Category Scores (Firm Maturity) 259 Figure 28: Mean Occurrences of Sub-Category Scores (Market-to-Book) 262 Figure 29: Mean Occurrences of Sub-Category Scores (Market Capitalization) 265 Figure 30: Mean Occurrences of Sub-Category Scores (Total Assets) 267 Figure 31: Mean Occurrences of Sub-Category Scores (Return on Assets) 270 Figure 32: Utility Functions of Preference Models 287 Figure 33: Extract of the Survey and Presentation of the Stimuli 310 Figure 34: Frequency of Survey Respondents by Institutional Classification 322 Figure 35: Frequency of Survey Respondents by Covered Asset Class 323 Figure 36: Frequency of Survey Respondents by Region of Origin 324 Figure 37: Ranking of Preferred Information Sources (Total Sample) 327 Figure 38: Ranking of Annual Financial Report Sections (Total Sample) 329 Figure 39: Ranking of Preferred Information Sources (All Analyst Groups) 332 Figure 40: Ranking of Financial Report Sections (Buy-Side vs Sell-Side) 335 Figure 41: Frequency of Valuation Methods (Total Sample) 339 Figure 42: Preferred Valuation Methods (Total Sample) 340 Figure 43: Preferred Valuation Method by Analyst Type 341 Figure 44: Preferred Valuation Method by Covered Asset Class 343 Figure 45: Ranking of Valuation Inputs (Total Sample) 348 Figure 46: Ranking of Valuation Inputs (Buy-Side vs Sell-Side) 354 Figure 47: Ranking of Valuation Inputs (Equity vs Fixed Income) 357 Figure 48: Part-Worth Utilities (Total Sample) 366 Figure 49: Averaged Importance Score (Total Sample) 370 Figure 50: Averaged Importance Score (Buy-Side vs Sell-Side) 374

List of Figures XXVII Figure 51: Averaged Importance Score (Equity vs Fixed Income) 376 Figure 52: Ideas to Improve the Reporting of Intangibles (Total Sample) 380 Figure 53: Reporting Preferences for Intangibles (Total Sample) 382 Figure 54: Further Design of Reporting Intangibles I (Total Sample) 384 Figure 55: Further Design of Reporting Intangibles II (Total Sample) 385 Figure 56: Ideas to Improve the Reporting of Intangibles (Buy- vs Sell-Side) 388 Figure 57: Further Design of Reporting Intangibles I (All Analyst Groups) 393 Figure 58: Further Design of Reporting Intangibles II (All Analyst Groups) 394

List of Tables XXIX

Table 1: Selected Classification Schemes of Intangible Values 50 Table 2: Reporting Example of the Skandia Navigator 104 Table 3: Exemplary Credit Scoring Summary (S&P) 142 Table 4: Typified Structure of Initiating Coverage Reports 194 Table 5: Sample of the Content Analysis 196 Table 6: Additional Firm Characteristics of Sample 218 Table 7: Overview of Mean Scores (Total Sample) 222 Table 8: Total Frequencies of Human Capital Themes 226 Table 9: Total Frequencies of Internal Capital Themes 232 Table 10: Total Frequencies of External Capital Themes 241 Table 11: Total Intangible Score by Recommendation 247 Table 12: Overview of Total Intangible Score by Time Period 251 Table 13: Overview of Total Intangible Score per Industry 254 Table 14: Mean Occurrences of Sub-Category Scores (Industry) 256 Table 15: Overview of Total Intangible Score by Firm Maturity 258 Table 16: Overview of Total Intangible Score by Market-to-Book Value 261 Table 17: Overview of Total Intangible Score by Market Capitalization 264 Table 18: Overview of Total Intangible Score by Total Assets 266 Table 19: Overview of Total Intangible Score by Return on Assets 269 Table 20: Overview of the Findings (Content Analysis) 272 Table 21: Structure of the Survey 279 Table 22: Investment Recommendation Task – Attributes and Levels 305 Table 23: Sample and Response Rate 314 Table 24: Frequency of Survey Respondents by Institutional Classification 321

Table 25: Frequency of Survey Respondents by Covered Asset Class 322 Table 26: Frequency of Survey Respondents by Region 323 Table 27: Survey Tasks related to Information Sources 326 Table 28: Comparison of Sample Means (General Information Sources) 331 Table 29: Comparison of Sample Means (Financial Report Sections) 334 Table 30: Survey Tasks related to Valuation Methods 338 Table 31: Survey Tasks related to Valuation Inputs 345 Table 32: Statistics for Valuation Inputs (Total Sample) 347 Table 33: Comparison of Sample Means (Valuation Inputs) 352 Table 34: Survey Tasks related to the Investment Recommendation 360 Table 35: Descriptive Statistics of the Ranked Profiles (Total Sample) 362 Table 36: Comparison of Attribute Levels for Profiles B and F 363 Table 37: Part-Worth Utility Scores for the Total Sample 365 Table 38: Correlations (Total Sample) 371 Table 39: Part-Worth Utilities (Buy-Side vs Sell-Side) 373 Table 40: Part-Worth Utilities (Equity vs Fixed Income) 375 Table 41: Survey Tasks related to Preferred Reporting Methods 378 Table 42: Ideas to Improve the Reporting of Intangibles (Buy- vs Sell-Side) 386 Table 43: Reporting Preference for Intangibles (Buy- vs Sell-Side) 389 Table 44: Reporting Preference for Intangibles (Equity vs Fixed Income) 391 Table 45: Further Design of Reporting Intangibles (Group Comparisons) 392

Relevance and Motivation of this Study 1

1 INTRODUCTION

Relevance and Motivation of this Study

1.1.

Academics and practitioners argue that the economic importance of intangible values

in industrialized countries has increased significantly during the past decades.1 This phenomenon is mainly due to the notable growth of the tertiary sector, resulting in fundamental changes of the economy: the traditional industrial business model has continuously become less important, as economic wealth creation is more and more based on the exchange and manipulation of invisible or intangible values.2 Major production factors do no longer comprise of tangible assets, such as property, plant and equipment, but rather of knowledge-based technology, human resources, and other intangible values.3 Today, the critical elements that are key to a business and that drive revenues are brands, copyrights, patents, licenses and the like

To highlight their economic relevance, NAKAMURA, for instance, empirically demonstrates that companies in the United States (U.S.) have invested one trillion U.S dollars in intangibles during the year 2000.4 In addition, estimates assume that intangible components account for a significant part of the market values of companies across different industries.5 In many instances, the significance of intangible values is also explicated by pointing out the companies’ increasing market-to-book ratios.6

Prominent examples that are often stressed are The Coca Cola Company, Microsoft or SAP, whose market values exceed their respective book values by 15 to 20 times.7

Moreover, LEV shows that the market-to-book ratios of the Standard and Poor’s (S&P)

500 companies continuously increased since the early 1980s.8 That is,

1 For instance, cf LEIBFRIED, P./FASSNACHT, A (2008), p 239; ACHLEITNER, A.-K./BEHR, G./SCHÄFER, D (2009), pp 92-93

2 Cf CANIBANO, L./GARCIA-AYUSO, M./SANCHEZ, P (2000), p 102

3 Cf SCHMALENBACH SOCIETY (2001), p 989; LEV, B (2001), p 1 et seqq.; KÜTING, K./WEBER, C.-P./WIRTH, J (2002), p 57

4 Cf NAKAMURA, L (2003), p 19 et seqq

5 Cf MAUL, K.-H./MENNINGER, J (2000), p 529; DAUM, J H (2003), p 4

6 In this case, the gap between the market and book value is typically assumed to be the value of a company’s intangible capacities

7 Cf DAUM, J (2003), p 4; ESSER, M./HACKENBERGER, J (2004), p 402

8 Cf LEV, B (2001), p 8 et seq D AUM further illustrates that the discrepancy between market capitalization and book values of S&P 500 firms grew in the same time period from an average of 20 percent to 75 percent of the total market value (cf DAUM, J H (2005), pp 4-5)

capital market participants are willing to pay a significant premium on top of the book value of an entity’s equity

The increasing gap between market and book values is further cited as an indicator of the decreasing relevance of financial accounting and reporting, such as the International Financial Reporting Standards (IFRSs) Since IFRSs9 only allow the recognition of certain intangible assets, many of a company’s invisible resources are omitted from the balance sheet and not further reported In particular, internally generated intangibles have to meet restrictive criteria in order to be capitalized The reason for the limited recognition is due to obstacles and issues associated with the characteristics of the traditional accounting model and the inherent nature of intangibles As a consequence, the book value of a company’s equity does not accurately reflect its market value and thus, financial statements are deemed to decrease in their relevance for their users

While high market-to-book ratios are not only caused by omitting to capitalize intangibles and financial reports are not actually designed to show a company’s market value, IFRSs still aim to assist with estimating such values More specifically, the purpose of IFRSs is to provide information that is useful for their primary users in making their decisions about allocating resources to a company.10 Yet, by potentially failing to recognize a major portion of an entity’s intangibles and not making any additional disclosures about them, IFRSs do not present their users with a complete and comprehensive picture of a company’s resources and claims The omission of clearly disclosing important information may have a variety of negative economic impacts for both, the preparers and users of financial statements Therefore, it is justified to discuss potential improvements of IFRSs in regard to the accounting and reporting of intangible values

Throughout the past decades, there has been an ongoing debate about how to improve IFRSs, with proposals ranging from the additional capitalization of intangible assets to

9 In this context, IFRSs encompass all standards published by the International Accounting Standards Board

(IASB), including their associated interpretations In particular, they also contain the International Accounting Standards (IAS) as issued by the International Accounting Standards Committee (IASC) In a narrow sense, the term only refers to the newly published standards In this thesis, the term may be used interchangeably

10 Cf Section 2.3.1

Purpose and Methodology of this Study 3

an extended business reporting.11 Yet, none of them actually prevailed As IFRSs focus on their pre-defined users, the improvements should be developed based on their particular information needs and preferences Hence, it is essential to understand whether or not the users even require information on intangibles and if so, how they use such information and what type of information they actually prefer As part of such an analysis, it is especially necessary to comprehend the users’ decision-making processes

Financial analysts are frequently mentioned as one of the main users of information derived from financial accounting and reporting.12 Even though, they do not directly provide companies with capital, they assist in making such decisions by collecting, processing and distributing information Thus, financial analysts play an important role

in the capital markets and are even referred to as representing the information needs and preferences of capital providers, the primary user group of IFRSs Accordingly, this thesis is concerned with financial analysts

Purpose and Methodology of this Study

1.2.

The present thesis examines the information use and needs of financial analysts with respect to intangible values The purpose is to shed light on the usefulness or importance of such information from the perspective of one of the primary user groups

of IFRSs While intangibles are deemed to have economic relevance, this thesis provides evidence about whether or not information on such values is actually used by financial analysts and if so, under what circumstances the analysts use such information and what type of information they consider as useful Yet, the investigation is not limited to intangibles that are currently recognized in financial accounting and reporting, but rather focuses on an entity’s overall intangible capacities that may be important to financial analysts Hence, the thesis further aims to identify current user demands and to define requirements that may be helpful in improving IFRSs in regard to intangible values

In order to achieve the research goal and to study intangibles and financial analysts, three sets of research questions, RQ1a/R1b, RQ2, RQ3a/RQ3b, were derived from the

11 Cf Section 3.4

12 Refer to the discussion in Section 4.2.3

general purpose of this thesis The questions were designed to assist in structuring the research process and guiding the analysis throughout the course of this study They were formulated as follows:

RQ1a: What are the key determinants that influence the decision-making of

financial analysts?

RQ1b: How do financial analysts potentially incorporate information on

intangible values in their decision-making?

RQ2: What are the types of intangible values that are considered by financial

analysts when making their decisions and how relevant are these areas?

RQ3a: How relevant is the information on intangible values for the

decision-making of financial analysts?

RQ3b: What are the preferences of financial analysts in terms of reporting

information on intangibles?

To study the research questions at hand, this thesis combines a theoretical and empirical approach That is, the first part employs theoretical analysis to examine the research objects related to this thesis, i.e financial accounting and reporting, intangible values and financial analysts The second part empirically explores the actual information use and the perceptions of financial analysts with respect to intangible values Based on the findings, the last part defines potential user requirements and demands for information on intangibles The following provides a more detailed overview of each of the chapters

Chapter 2 introduces the fundamentals of financial accounting and reporting First, the chapter explains the different theories, justifying the existence of financial accounting and reporting, and discusses the consequences and determinants for defining an accounting system Second, the principles of capital markets-oriented financial accounting and reporting are introduced, identifying the primary users and objectives

of IFRSs Third, the chapter further stresses the definition of useful information and specifies the design that IFRSs employ in order to provide information The discussion

is essential to understand the potential deficits of current accounting and financial reporting and establishes the theoretical basis for the further analysis

Purpose and Methodology of this Study 5 Chapter 3 provides an overview of the foundations and challenges of intangible values

in financial accounting and reporting The first part of this chapter defines and distinguishes intangibles from tangible items In addition, the economic properties of intangible values are discussed and potential classification frameworks are presented The second part examines the present state of IFRSs, introducing the currently effective accounting and reporting guidelines for initially recognizing and measuring intangible assets Based on this analysis, the perceived deficiencies and constraints of the existing requirements are discussed, investigating the reasons and indicating the potential impact of disclosing incomplete information about a company’s resources and claims Accordingly, the last part of this chapter illustrates different approaches that have been introduced to improve the accounting and reporting of intangible values The analysis shows that many different methods are available to report additional information on intangibles Yet, the approaches should correspond to the needs and preferences of financial statement users

Chapter 4 introduces the group of financial analysts, who may be viewed as part of the primary users of IFRSs, even though they do not directly provide capital to a company

As a first step, the chapter presents the fundamentals of financial analysts, defining their functions and explicating the different classifications schemes This thesis is mainly concerned with buy-side and sell-side analysts as well as equity and fixed income analysts As a second step, the chapter examines the different phases relating

to the decision-making processes of financial analysts, including the collection, processing and distributing of information Lastly, the chapter investigates the analytical tools and valuation methods available to financial analysts in order to explore what type of information is used and how information on intangible values may potentially be incorporated in the decisions of financial analysts Moreover, the section further discusses other factors that may influence the use of information on intangible values

In addition to the theoretical analysis, Chapter 5 reports the findings of two different empirical studies that explored the actual information use and the perceptions of financial analysts regarding intangible values First, content analysis was employed to examine the information included in sell-side research reports The analysis revealed that sell-side analysts include different information on intangibles in their research reports based on many different circumstances Second, a self-administered web-based

experimental survey was employed to study the perceptions of different analyst groups

in regard to information on intangible values The experimental part of the survey observed data derived from actual decisions Moreover, the analysts were inquired for their preferences on reporting information on intangibles

In summarizing the overall results, Chapter 6 provides answers to the different research questions that guided the analysis as well as to the general purpose of this thesis Based on the findings, the chapter further derives several recommendations of how to improve the accounting and reporting of intangible values Figure 1 illustrates the research process of this thesis:

Figure 1: Structure of this Thesis

(Source: Own Illustration)

Introduction to the Chapter 7

2 THE FUNDAMENTALS OF FINANCIAL ACCOUNTING AND

IFRSs center their objectives around entities whose securities14 are listed and traded on

an accredited exchange.15 That is why the following paragraphs examine the accounting function within a capital markets context Economic and finance theory is employed in order to justify and to explain the existence of financial accounting and reporting Based on this analysis, the objectives and potential user groups of IFRSs are further explicated Then, the subsequent section outlines the definition and characteristics of decision-useful information, as outlined by the CONCEPTUAL FRAMEWORK of IFRSs

Justification for the Existence of Financial Accounting and

2.2.

Reporting

This section draws upon the efficient-markets hypothesis and the agency problem to justify the existence of financial accounting and reporting The former is embedded in neoclassical economic and finance theory and focuses on information processing on capital markets The agency problem is a major part of new institutional economics

13 According to G ASSEN , the objectives of financial accounting are crucial determinants of standard setting and research (cf GASSEN, J (2008), p 2) Similarly, C HAMBERS argues that accounting definitions are a matter of choice, leading to quite different purpose or objects (CHAMBERS, R J (1965), p 37)

14 The term security is to be interpreted in a broad manner That is, a security may refer to an entity’s listed

equity, e.g stocks, or to its debt instruments, such as publicly traded bonds and debentures

15 Cf BOHL, W (2006), § 1 para 29 Accordingly, companies governed by the law of an European Union’s (EU) member state have to prepare their consolidated financials in conformity with IFRSs, if their securities are admitted to trading on a regulated market of any member state (cf REG (EC) 1606/2002, Article 4)

and explains and intends to solve the problem of information asymmetries in different settings

2.2.1 Neoclassical Economic and Finance Theory

The neoclassical view in finance theory builds its analytical models upon two major assumptions: the homo economicus and perfect competition.16 The former implies that market participants act rationally and intend to maximize their individual utility function.17 Perfectly competitive financial markets are characterized by different conditions Besides the notion about rational and utility optimizing behavior,

 market participants are price takers and have perfect information;

 neither trading costs nor taxes nor any other market barriers exist; and

 all assets are perfectly divisible as well as tradable.18

In such markets, financial accounting and reporting appears to be obsolete Under the above circumstances, no frictions exist at all All value relevant information is available to every market participant as there are no information asymmetries.19

Market prices reflect the actual fundamental values of companies.20 Hence, the legitimacy of financial accounting and reporting as information source in capital markets cannot really be explained by simply employing the narrow assumptions of perfectly competitive markets

The price on perfectly competitive markets may also be considered as pareto-efficient,

as all resources on such markets, e.g capital, are perfectly allocated and no market participant can be better off without making one worse off.21 However, perfectly competitive markets and pareto-efficiency have to be distinguished from the idea of market efficiency The former is especially concerned with the market equilibrium and

16 Cf SCHMIDT-TANK, S (2005), p 11 et seqq For example, the efficient-market-hypothesis, the walk-hypothesis, the fair-game-model as well as the capital asset pricing model or the Modigliani-Miller- theorem are models in finance theory that are based on neoclassical views (cf RUMMER, M (2006), p 13 with additional references)

random-17 Cf MANKIW, N G (2001), p 4 et seqq For an introduction of how market participants are characterized

in economic theory For a detailed overview of the homo economicus and its application in economics and other social sciences cf KIRCHGÄSSNER, G (2008), p 1 et seqq

18 Cf COPELAND, T E./WESTON, J F (1992), p 331; STEINER, M./BRUNS, C (2007), p 3

19 Cf WICHELS, D (2002), p 44

20 Cf VELTE, P (2008), p 20

21 Cf VORSTIUS, S (2004), p 16