Executive Summary
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Intellectual capital is knowledge that transforms raw materials and makes them more valuable.
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Conventional accounting fails to measure the value of intellectual capital, but markets clearly reward it.
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Intellectual capital includes the talent of staff, the value of proprietary knowledge and processes, and the value of relationships with customers and suppliers.
Introduction
Intellectual capital is just that: a capital asset consisting of intellectual material. To be considered intellectual capital, knowledge must be an asset able to be used to create wealth. Thus, intellectual capital includes the talents and skills of individuals and groups; technological and social networks and the software and culture that connect them; and intellectual property such as patents, copyrights, methods, procedures, archives, etc. It excludes knowledge or information not involved in production or wealth creation. Just as raw materials such as iron ore should not be confused with an asset such as a steel mill, so knowledge materials such as data or miscellaneous facts ought not to be confused with knowledge assets.
Intellectual Capital As an Asset
From the standpoint of traditional accounting, intellectual capital frequently does not fit the definition of an asset. Generally, under accounting rules, an asset must be tangible; it must have been acquired in one or more transactions, so that it has a known cost or a market value; and it must be under the control of the party whose asset it is said to be. Thus, scientific skill is not an accounting asset, but laboratory equipment is.
Intellectual capital theory argues that this definition is too narrow and hinders businesses from seeing, managing, or building knowledge assets. This in turn inhibits companies’ ability to compete and prosper in an economy in which knowledge has become an important source of profits. The intellectual capitalists use a looser definition: an asset is something that transforms raw material into something more valuable. It is a magician’s black box. Inputs get put in—a few handkerchiefs, say; the asset does something to transform them; and out come outputs worth more than the inputs —rabbits, maybe. The question of ownership and control matters less than the question of access. A corporation might not own scientific expertise (in the form of a cadre of employees, for example), but it has the use of it and can exert a quasi-proprietary influence over how it is used.
Intellectual capital, then, is knowledge that transforms raw materials and makes them more valuable. The raw materials might be physical—knowledge of the formula for Coca-Cola is an intellectual asset that transforms a few cents’ worth of sugar, water, carbon dioxide, and flavorings into a dollar’s worth of refreshment. The raw material might be intangible, like information. Knowledge of the law is an intellectual asset; a lawyer takes the facts of a dispute (raw material), transforms them through his knowledge of the law (an intellectual asset), to produce an opinion or a legal brief (an output of higher value than the facts by themselves).
Though financial accounting does not measure intellectual capital, markets clearly do. Stock in companies in the pharmaceutical industry, for example, generally trade at a high premium over the book value of their assets, and the companies’ return on net assets is abnormally high; but if their spending on research and development is added to their capital, both their market-to-book ratios and their returns on assets come to resemble those of less knowledge-intensive companies. (There is a slowly growing movement to find ways to account for intellectual capital and report it to stockholders. Scandinavian countries, particularly Denmark, are leaders in the field.)
Indeed, it was the unusual behavior of the equities of knowledge-intensive companies that first drew the attention of analysts to intellectual capital. The term seems to have been employed first in 1958, when two financial analysts, describing the stockmarket valuations of several small, science-based companies, concluded that “The intellectual capital of such companies is perhaps their single most important element,” and noted that their high stock valuations might be termed an “intellectual premium.” (Morris Kronfeld and Arthur Rock, “Some Considerations of the Infinite,” The Analyst’s Journal, November 1958, p. 6.) The idea lay dormant for a quarter of a century. In the 1980s, Walter Wriston, the former chairman of Citicorp, noted that his bank and other corporations possessed valuable intellectual capital that accountants (and bank regulators) did not measure.
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