The value relevance of intellectual capital disclosure: empirical evidence from Kuwait

Author:Mishari M. Alfraih
Position:Department of Accounting, College of Business Studies, The Public Authority for Applied Education and Training, Kuwait City, Kuwait
Pages:22-38
SUMMARY

Purpose Drawing on market efficiency theory and studies on intellectual capital (IC) disclosure, this study aims to examine if IC information provided in the corporate annual reports of Kuwait Stock Exchange (KSE) listed companies in 2013 is value-relevant. Design/methodology/approach The analysis is divided into two parts. First, the level of intellectual capital disclosure (ICD)... (see full summary)

 
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The value relevance of
intellectual capital disclosure:
empirical evidence from Kuwait
Mishari M. Alfraih
Department of Accounting, College of Business Studies,
The Public Authority for Applied Education and Training, Kuwait City, Kuwait
Abstract
Purpose Drawing on market efciency theory and studies on intellectual capital (IC) disclosure, this study
aims to examine if IC information provided in the corporate annual reports of Kuwait Stock Exchange (KSE)
listed companies in 2013 is value-relevant.
Design/methodology/approach The analysis is divided into two parts. First, the level of intellectual
capital disclosure (ICD) of KSE-listed companies is examined using the content analysis method. Second, the
value relevance of nancial reporting is examined empirically using Ohlson’s (1995) valuation model.
Findings The results reveal that ICD is positively and signicantly associated with market value,
suggesting that greater ICD is valued by KSE market participants, who incorporate it into their valuation
models.
Practical implications Given the importance of ICD in enhancing equity valuation, a practical
implication of this study is to make managers aware of its positive and signicant effect on equity valuation,
which may encourage companies to increase their level of disclosure.
Originality/value This is the rst study of the association between the level of ICD and the value
relevance of nancial reporting for market participants in Kuwait. It therefore extends and conrms the prior
literature by broadening its scope to include frontier markets. Furthermore, it provides empirical evidence in
support of recent calls from regulators and professional bodies for information that supplements and
complements traditional nancial reporting.
Keywords Kuwait, Intellectual capital, Disclosure, Value relevance, Annual reports,
Financial reporting
Paper type Research paper
1. Introduction
Corporate nancial reporting is one of the key ways in which companies communicate with
stakeholders; however, rapid changes in the broader business environment have increased
concerns about whether it continues to full its objectives (Kriz and Blomme, 2016). The
issue has become particularly apparent in the context of the dramatic shift from the
industrial economy, dominated by tangible resources, to a knowledge-based economy, in
which nonnancial information and intellectual capital (IC) are critical resources and key
determinants of competitive advantage, economic success and value creation (Lev et al.,
2005). In this new economy, intangible assets such as IC are acknowledged as more
important for value creation than physical assets (Ellis and Seng, 2015). Although there is a
lack of consensus on the denition of IC, the literature broadly denes it as the knowledge,
information, intellectual property and experience that can be used to create wealth
(García-Meca and Martínez, 2005;Branco et al., 2010). IC assumes an intangible nature, which
distinguishes it from the resources, is recognized in traditional nancial reporting (Branco
et al., 2010). It can be thought of as a form of “unaccounted capital” in the traditional
accounting system (Abeysekera and Guthrie, 2005). Investors need information that goes
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
JFRC
25,1
22
Journalof Financial Regulation
andCompliance
Vol.25 No. 1, 2017
pp.22-38
©Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-06-2016-0053
beyond traditional nancial reporting to help them fully evaluate investment opportunities
and risks.
Many researchers have recognized that IC, which consists of nonnancial measures and
other information, drives the value and competitive advantage of a company (Moon and
Kym, 2006). For example, in a 2015 study of corporate nonnancial information conducted
by Ernst & Young (EY) on a sample of more than 200 institutional investors worldwide, 80
per cent of respondents considered nonnancial information to be essential or important
when making investment decisions. Although many companies seek to meet their current
and prospective investors’ needs by complementing traditional nancial reporting with
nonnancial (including IC) information (Haji and Ghazali, 2013), the practice is not yet part of
the mainstream (EY, 2015). While there is a substantial body of knowledge concerning the
presence and determinants of ICD in corporate annual reports (Graaf, 2013), there is a lack of
knowledge concerning the role of IC information in capital markets.
Claims that ICD has the potential to improve the efciency of capital markets and lead to
more informed investment decisions have led to various research initiatives (Petty and
Guthrie, 2000;Graaf, 2013). Value relevance research is one aspect of capital market research,
and is based on the premise that, if accounting information is useful, investors will adjust
their behaviour and the market will respond quickly through a change in stock price.
Consequently, corporate information is considered value relevant if it is accompanied by a
change in stock price (Kothari, 2001). The role of accounting information in company
valuation is of fundamental interest to analysts, investors and researchers alike (Habib and
Azim, 2008). However, researchers have found that the value relevance of traditional
nancial reporting has declined in recent years (Collins et al., 1997;Lev and Zarowin, 1999;
Francis and Schipper, 1999;Alfraih, 2016;Givoly et al., 2016). Lev and Zarowin (1999)
attribute this decline to changes in the business environment. They note that it does not
sufciently capture the impact of change on a company’s operations or economic conditions,
which creates a mismatch between revenue and costs. Similarly, Vafaei et al. (2011) attribute
it to a change in accounting regimes; this is compounded by the nding that value-generating
phenomena are not captured by the prevailing reporting frameworks.
Both the theoretical and empirical literature documents the value relevance of
nonnancial information and suggests that there is an important complementary
relationship between traditional nancial (earnings, book value and cash ow) and
nonnancial variables (Amir and Lev, 1996;Lev and Zarowin, 1999). In an empirical study of
a sample of companies listed on the British, Australian, Hong Kongese and Singaporean
Stock Markets, Vafaei et al. (2011) document the value relevance of IC information in equity
valuation. Similar results were obtained by Gamerschlag (2013) using a German sample, and
Ellis and Seng (2015) using a sample from New Zealand. In contrast, a study in Italy by
Ferraro and Veltri (2011), and in the USA by Kehelwalatenna and Premaratne (2013), failed
to document a conclusive relation with market value.
Although prior empirical research has investigated the idea that IC information is
value-relevant in equity valuation, most studies have been conducted in developed and
emerging markets. Sukumaran et al. (2015) argue that in contrast to developed markets,
frontier equity markets are smaller and less accessible and can be seen as a subclass of
emerging markets. MSCI, a leading provider of global indexes, currently lists 23 markets[1]
in its frontier markets index; Kuwait is a key element (MSCI, 2016).
To the best of the author’s knowledge, there is no research that explores the value
relevance of ICD in frontier markets. This study seeks to address this gap in the literature by
examining the role of ICD in the frontier market of Kuwait. Specically, this paper examines
whether IC information disclosed in the corporate annual reports of companies listed on the
23
Intellectual
capital
disclosure

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