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Thought Leadership


The Latent Value of Corporations

Business World, December 05, 2005

BY INVITATION: SRIDHAR MITTA

There is a need for CEOs and CFOs to delve deeper into issues relating to Intellectual Capital and to unearth the latent value of their companies.

The author is managing director and chief technology officer of e4e India and serves on the advisory board of Bizworth,accompany focused on intellectual capital services.

Chief executive officers (CEO) and chief finance officers (CFO) are well aware that market capitalization represents a corporation's future value, whereas book value indicates the current value of net physical assets. The difference is explained by intangibles like goodwill, market leadership and patents. These intangibles contribute to the latent value of a corporation.
Over time, the latent value of corporations has been increasing phenomenally. Take Infosys, whose share price is around Rs 2,650, while its book value per share is only Rs 192. This implies that the ratio of price to book value of the company is about 14 times. In other words, intangibles represent a whopping 93 per cent of the share price!
One may justify this disparity as a natural factor in knowledge-based industries like IT or biotechnology. But even some traditional brick and mortar industries are clocking similar ratios. For Maruti Udyog, the price-to-book value ratio is about four times, and intangibles represent 74 per cent. The global scenario endorses this fact even more emphatically. An analysis of flagship Standard & Poor Index of the US illustrates that the value of intangibles of its listed companies has risen to 85 per cent in 2000 from a mere 20 per cent in 1980.

Yet, most CEOs and CFOs spend most of their bandwidth in managing current value by analyzing financial reports and balance sheets rather than the increasingly important latent value. The list of intangibles contributing to latent value is expanding to include technology, human capital, brands, processes and customer loyalty - together called Intellectual Capital. There is a need for CEOs and CFOs to understand issues relating to management of Intellectual Capital and unearth the latent value of their corporations.
However, till recently, there haven't been tools or methodologies to measure and manage Intellectual Capital.
It is clear that traditional command and control mechanisms and systems driven by policy, budget and procedure will not work for measuring intellectual capital. For example, human capital is distinctive in that the true owner of the capital (the employee) decides anew, each and every day, how much capital he/she wishes to invest. Can traditional command and control metrics really measure and motivate this investment of capital by the employee each day?

Similarly, risk management and, therefore, corporate governance cannot be restricted to protecting and nurturing physical assets. This means, for example, that traditional asset insurance and internal controls are not adequate to protect the full value of organizations. New forms of risk management and response-mechanisms are needed.

Increasingly, corporations and regulatory bodies throughout the world are recognizing this perilous divide between historical financials and future value. They are taking steps to bridge the gap. Scandinavian countries have led the effort in this field. Thought leaders like Karl Sveiby, Leif Edvinsson and Goran Roos have researched the science of Intellectual Capital in recent years. They have developed methodologies and tools like 'IC Rating' and 'IC Value' to measure Intellectual Capital, and have refined earlier tools like the balanced scorecard. Even governments have started taking cognizance of latent value, and they are now enacting guidelines akin to financial reporting. Denmark is the first country to stipulate guidelines for reporting on Intellectual Capital.

India Inc. has also begun to look into their latent value and manage Intellectual Capital in a formal way. Companies like Infosys, MindTree and even e4e are pioneering these efforts. In its annual report, Infosys states the value of its human capital and brand, while e4e and MindTree are working on their IC Rating.

Most certainly, the time has come for serious efforts to manage Intellectual Capital and unleash the latent value of corporations.
For more information contact SR Gopalan at +91 80 41142626
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