Dr . Anne‐Laure Mention, CRP Henri Tudor & WICI L bLuxembourg

Prof. Stefano Zambon, University of Ferrara & Ch i  WICI EChairman, WICI Europe

Agendag Increasing importance of intangibles …I   h  K l d  E In the Knowledge Economy

Impact for society  Overview of selected initiatives WICI in action : an illustration  Conclusions

Intangibles vs Tangibles 

Tangibles 

g g

Tangibles Value1930 – Intangibles value 

d  hl   %  represented roughly 30%  

of the market value of 

major corporationsIntangibles 

value

major corporations.

2000 – Intangibles value 

represented 80‐85%.p 5

2005 – And beyond ? 

3Source: Werner & Heimer, 2008

Knowledge economy & intangibles

“The substantial foundation of the industrial corporation is its immaterial assets”corporation is its immaterial assets

“Th    b   li  diffi l i  i   h     f “There may be peculiar difficulties in the way of reducing this goodwill to the form of a fund, expressing it in terms of a standard unit”expressing it in terms of a standard unit

h blThorstein Veblen, 1904‐>  more than 100 years later, still a topical issue 

4

The role of financial analystsy Financial analysts may and should play a key role inidentifying WHAT to report and HOW toidentifying WHAT to report and HOW tocommunicate on the new value drivers

Research has demonstrated a relatively weak attitude Research has demonstrated a relatively weak attitude,lacking proactivity vis‐à‐vis (e)‐valuation ofintangiblesintangibles

Standard & Poor’s Moody’s Fitch Ratings

HUMAN CAPITAL - Management track record- Risk tolerance

- Management track record,motivation, quality

- Management track record and flexibility, q y

- Risk tolerance- Turnover

- Risk tolerance

RELATIONAL - Customer serviceProduct innovativeness quality and

- “Franchise strength”(Products’ quality &

- Market shareCapacity to influence priceCAPITAL - Product innovativeness, quality and

price, distribution capabilities- Reputation/External image

(Products’ quality & innovativeness,

diversification in general,distribution strategy)

- Brand and IP

- Capacity to influence price- Marketing expenses

- Products leadership degree- Reputation

G hi l di ifi ti- Brand and IP- Client service

- Geographical diversification- Others

ORGANISATIONAL CAPITAL

- Size (impact on the financial flexibility)

- Diversification

- Product/service innovativeness (also R&D expenses)

- Size (impact on the financial

- Size (impact on the financial flexibility)

- Product/service diversificationDiversification- Technology

Size (impact on the financial flexibility)

- Technology

Product/service diversification- Distribution channels

STRATEGY - Valuation of the potential credit impact of alternative strategic

- Growth strategy- Long-term vision

-Consistency between strategy & organisational structurep g

initiatives- Consistency between strategy and

organisational structure

Long term vision- Risk-return tolerance

g- Acquisitions

CORPORATE - Ownership structure (impact on the fi i l fl ibilit d lidit )

- Ownership structure (impact - Similar to Moody’s

GOVERNANCEfinancial flexibility and solidity) on financial flexibility & solidity)

- Equilibrium of responsibility- Adequacy of delegation

mechanismsMiddl t i l t

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- Middle management involvement- Conflict of interests

Main results emerging from the content analysis of documents regarding the intangible resources considered in the credit rating process – Source: in Zambon and Marzo, 2007 

HUMAN CAPITAL Confirmed the relevance of managers’ track record as proxy of competence, ability, etc.Less attention on the other employees’ skills and capabilitiesTraining activity scarcely analysed (just in case of problems)

RELATIONAL CAPITAL

Sales and Market shareCustomer satisfaction (derived indirectly form sales)/ reputation (impact on financial stability)

Brand (in terms of capacity to maintain o increasing the product price) Dependence on one or few clients/suppliers (negative/risk implication)/ Diversification is positivep pp ( g p ) p

Internationalisation (positive, risk implication)No internal image (of the employees), just a focus on turnover in some critical cases

Relations with Unions (only it is a source of instability)Marketing e penses: not cr cialMarketing expenses: not crucial

Communication:- External: scepticism towards supplementary statements (social/environmental/sustainability, etc.)

- Internal: just if problematic (consistency of management objectives with strategy)ORGANISATIONAL

CAPITAL

R&D always important (comparative analysis by industry)Technology, according to the industry

Level of innovativeness (can increase the risk)Diversification (both geographical and of products) is always positive( g g p p ) y p

Change in corporate culture (motivation and management)Ownership structure

Personnel compensation mechanismsRi k t l /St l f t ( i i i k )STRATEGY Risk tolerance/Style of management (aggressive is more risky)

Cohesion/coherence between strategy and culture/Feasibility of strategy

CORPORATE Relevant, especially the ownership structure, in terms of financial solidity.Also board composition no of meetings audit committee expertise and independence executive

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GOVERNANCEAlso board composition, no. of meetings, audit committee expertise and independence, executive

compensation strategiesMain results emerging from the interviews with the analysts regarding the intangible aspects considered in the credit rating process by the 3 top agencies

Overview of selected initiatives

I li  F d i   f Fi i l A l  (AIAF) Italian Federation of Financial Analysts (AIAF) EFFAS – Ten Principles for Effective IC disclosure  WICI – Mission & Vision  Illustration 

THE MODEL FOR RANKING IC & INTANGIBLES DISCLOSURE by Italian Association of Financial Analysts & Univ  of 

Level 1Minimal information:- enclosed in the annual report (MD&A)

DISCLOSURE by Italian Association of Financial Analysts & Univ. of Ferrara, 2002

enclosed in the annual report (MD&A)- mainly orientated to actual figures

Level 2Extended information:

LEVEL 3Full IC Report

- enclosed in the annual report (MD&A)- orientated also towards prospective information- IC information is generally disclosed in ad hoc Table

Level 3

LEVEL 2Synthetic information

ith d h t bl

Level 3Extended and autonomous information:- Ad hoc report on IC and intangibles

Strategy & Business Modelwith an ad hoc table in the annual report

Organisation

Innovation & IPR

LEVEL 1Minimal information

Customers/Suppliers

Human resources

g

9

INFO ON CURRENT SITUATION PROSPECTIVE INFO

Recommended structure

Firm levelMetrics specific to the

firm – no limitFirm level firm no limit

Sector levelMetrics characterizing

sector( )(20-25 max.)

General Universal metrics(3-5 max )(3-5 max.)

Combine specificity and comparability – Source : Zambon, WICI 10

EFFAS – 10 Principles for effectiveEFFAS – 10 Principles for effective communication of IC

Why and howthe financial communitythe financial communityshould tackle intangibles– now

Effective communication of IC (1/10)( / )1. Clear link to future value creation

The indicators should enhance the basis for decisions of bothinternal and external parties. Only those indicators that are also usedfor internal management are relevant for investors To that endfor internal management are relevant for investors. To that end,indicators should exhibit a clear link to the company’s future valuecreation.

More specifically, analysts and investors are interested in indicatorsdirectly related to a company’s operating and/or financial marketperformance. It might be necessary to further clarify this link in anarrative fashion. In addition, an ideal indicator would be one that couldbe “modelized”, i. e. included in quantitative valuation frameworks

12

Effective communication of IC (2/10)( / )

2 Transparency of methodology2. Transparency of methodology

Companies should explain how they have built the indicators disclosed.“Easy to measure” often means “easy to understand” and thusEasy to measure often means easy to understand” and thuseffective in communication.

Th l l ti th d h ld b d i d f th i t l tThe calculation method should be derived from the internal managementsystem. This helps to ensure that the benefit attributable to the use ofthe indicator exceeds the cost for obtaining the information.

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Effective communication of IC (3/10)Effective communication of IC (3/10)3. Standardisation

A transparent methodology facilitates a more fertile discussion with analystsabout the company’s potential and performance. The resulting deeperunderstanding in turn enables analysts to compare different indicator

h E t ll k t f ld th l d t th fapproaches. Eventually, market forces would then lead to the emergence of a“market best practice” in the calculation and disclosure of intellectual capitalindicators. This is a crucial step: only standardised intangibles indicators canbe benchmarked between companies and only benchmarked indicatorsbe benchmarked between companies, and only benchmarked indicatorsare truly useful.

For the time being, we would prefer the market-driven approach to theg, p ppimposition of mandatory standards on a detailed level, as leeway is still neededfor collaborative experimentation including both companies andanalysts/investors. Ultimately, we think indicator standardisation should exhibitthree levels of specificity. Indicators on the low level should be generallyapplicable, i. e. they should be relevant for most or all sectors and companies.Indicators on the middle level should be those specific to a certain sector (using

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a sector taxonomy already broadly used in the financial community). Indicatorson the top level should be those specific to the individual company.

Effective communication of IC (4/10)4. Consistency over time

The second possible dimension of benchmarking is to compare today’sThe second possible dimension of benchmarking is to compare today sindicator values to historical ones for the same company. To enable that,the set of indicators chosen has to be as consistent over time aspossible When a company decides to replace an indicator a rationalepossible. When a company decides to replace an indicator, a rationaleshould be given (for instance, to align it to a change in the company’sstrategy).

As long as standardisation has not progressed far enough, there is a riskof “indicator moral hazard”: We should strive to help companies counterth b i t t ti t l i di t ith th t tlthe obvious temptation to replace indicators with new ones that currentlyseem to portray them more favourably.

15

Effective communication of IC (5/10)( / )5. Balanced trade-off between disclosure and privacy

Indiscriminate disclosure of information on IC could in some cases resultin competitive disadvantages. It is thus indispensable to search for theright balance between the disclosure of intellectual capital andprivacy issues. The publication of such information should always bepreceded by a careful internal management decision process.p y g p

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Effective communication of IC (6/10)( / )6. Alignment of interests between company and investors

Progresses in the disclosure of IC may only be achieved by aligning theinterests of the company, asked to provide a higher quantity of better

lit i f ti t th t id ld d th i t h illquality information to the outside world, and the investor, who will usethis information within his or her valuation framework. Where truealignment proves difficult, an adequate compromise should be aimed at.

One important issue to be covered is the disclosure/privacy balancediscussed above. Another relates to cost/benefit considerations, on thesides of both the disclosing company and analysts/investors.

17

Effective communication of IC (7/10)( / )7. Prevention of information overflow

Analysts and investors are confronted with a substantial stream ofinformation already today. Thus, while there is a clear lack of informationy yon companies’ intellectual capital, this information should be focusedon the most crucial indicators.

Only then will analysts and investors be able to work with the additionalinformation on a day-to-day basis and closely integrate it into theirvaluation frameworks Corporates should privilege relevance instead ofvaluation frameworks. Corporates should privilege relevance instead ofquantity also when publishing a separate Intellectual Capital Report.

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Effective communication of IC (8/10)8. Reliability and responsibility

As any reported company information information on IC should of course reflectAs any reported company information, information on IC should of course reflectthe true corporate situation. Both the choice of indicators and the calculation oftheir values should be objective in portraying the company’s potential. Moreover,the indicator values should be verifiable: it should be possible to track thethe indicator values should be verifiable: it should be possible to track thesources of information in order to check accuracy (which also implies theneed for transparent indicator calculation methods, see principle 2).

On a more practical note, information on a company’s IC should be a true andfair expression of its existing internal measurement system or the result of acustom-made, transparent assessment process. The latter could beconducted either internally or by third parties. In addition to externalassurance, the assignment of internal management responsibility (on board orsenior management level) for the information disclosed will be necessary.

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Effective communication of IC (9/10)( / )9. Risk assessment

Where feasible, disclosed information on a company’s IC should beaccompanied by an assessment of the risks inherent to eachindicator This should include those possible future events and theirindicator. This should include those possible future events and theirprobability that might endanger a company’s operating performance.

For instance with reference to human capital this refers to the risk ofFor instance, with reference to human capital, this refers to the risk ofkey employees leaving the firm. Risks are obviously higher when thiskey personnel carries confidential and/or strategic knowledge. Anotherimportant examples are risks to a company’s reputation.

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Effective communication of IC (10/10)Effective communication of IC (10/10)10. Effective disclosure placement and timing

Finally, information on a company’s IC should be communicated through bothefficient and effective channels, and with an adequate frequency. In our view, anappropriate place for broader information on a company’s IC, as discussed in thispp p p p y ,paper, would be the “Management Commentary” (or “Management Discussion andAnalysis”) within the annual report. Here, IC indicators can and should be embeddedin narrative where necessary to clarify their meaning and link to the company’sfuture value creation. The publication of a separate Intellectual Capital Report isanother possibility, to be deliberated in the context of the company’s whole reportingsystem.

Both ways would suggest a publication frequency synchronised with the annualreport. External stakeholders might ask to be provided with information on someparticularly important indicators of IC (or the associated risk assessments) morefrequently, though.

We would not rule out the notion of integrating broad information on IC into either thebalance sheet the profit and loss or the cashflow statements This being subject to

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balance sheet, the profit and loss or the cashflow statements. This being subject tovaluation from accounting standard setters and a broader stakeholder community.

WICI – World Intellectual CapitalWICI – World Intellectual Capital Initiative  Private/public sector collaboration aimed at improving capital

allocation through better corporate reporting informationP ti  P ti   f WICI  Promoting Parties of WICI are: Enhanced Business Reporting Consortium, which was founded by 

American Institute of Certified Public Accountants, Grant Thornton LLP  Microsoft Corporation and PricewaterhouseCoopersThornton LLP, Microsoft Corporation and PricewaterhouseCoopers

European Federation of Financial Analysts Societies Japanese Ministry of Economy, Trade and Industry

O i ti  f  E i  C ti   d D l t Organization for Economic Cooperation and Development Society for Knowledge Economics University of Ferrara Waseda University EC and BNDES as observers

http://www.wici‐global.com/p // g /

WICI VISIONFUTURE201720122007

Value Creation

Maximization SustainableMaximization Sustainable

Intellectual Capital/Assets‐based Management

Monetary/FinancialCapital

PhysicalCapital

HumanCapital

EVALUATIONUTILIZATIONRECOGNITION

Relational Organization

Intellectual Capital/Assets

EVALUATIONUTILIZATIONRECOGNITION

Relational Capital

Organizational Capital

Entire Society and Economy 23

WICI Conduct

Identify and promote industry‐specific KPIs (Key Performance Indicators) so to favor  WICIWICI Conduct

awareness‐building activities for many organizations and 

Indicators) so to favor the organizations to realize the substance of the “IAbM”, as well as to disseminate and 

WICI

MISSIO

①⑤

organizations and investors to understand and implement the concept of 

to disseminate and build on the idea that these industry‐specific KPIs are NOT a set of indicators that 

①⑤

MISSION

concept of “Intellectual Capital/Assets‐based Management” in a 

indicators that organizations must disclose, but rather that the organizations can freely select to fit 

MissionKPI

０１０１０１０１０１０１０１０１０１０１０１０１０１０１XBRL ②④

Management  in a positive and constructive way.

Provide a regularly 

can freely select to fit with the substance and features of their own management and value creation processes

０１０１０１０１０１０１０１０１０１０１０１０１０１０１XBRL ②④

０１０１０１０１０１０１００１０１０１０１０１０

Provide a regularly updated reporting and disclosure framework as a tool for an 

Elaborate a reporting framework that since the beginning it is 

creation processes. １０１０１０１０１０１０１０１０１０１００１０１０１０１０１０

③

tool for an improved communication between any organizations and P ti i t   ti l  i  th  di i   b t  th  

the beginning it is also expressed in, and integrated with, a digital standardized technological 

③organizations and their stakeholders about “IAbM”.

Participate actively in the discussion about other internationally recognized reporting and disclosure frameworks, and provide WICI inputs into the emerging globally accepted framework in this field.

technological language, such as XBRL.

24

WICI Activities – past & present201220112010

WICI Activities – past & present200920082007 201220112010200920082007

WICIStarted

WICI Concept Paper(Framework)

WICI KPI Concept

Paper

WICI 1st Taxonomy

WICI Japan started WICI Europe started

Dec 2nd Dec 1stNov 20thNov 19th

( )p

Industry‐KPIs Projects : Automobile / Electronic Devices / Pharmaceutical / Telecommunications /Fashion & Luxury

Dec 2nd

“Challenges to Integrated BusinessReporting”

Dec 1st“Strategic corporate

management in Integrated

Reporting Era”

Oct 31st“Towards substantial disclosure

beyond the form”

Nov 20th

“Business communication

frontier”

Nov 19th“Value

Creation Management

and Interactive Data”

WICI Symposia(Tokyo)

Reporting EraData

GRI G4GRI G4EC Internal

MarketEC Internal

MarketEC Transparency DirectiveEC Transparency Directive

Global Discussion/ Comment submitted

IIRCDiscussion Paper

IIRCDiscussion Paper

IASB’s Exposure Draft on Management CommentaryIASB’s Exposure Draft on Management Commentary

EC Workshops of ESG DisclosureEC Workshops of ESG Disclosure

Collaboration with IIRC

25Connectivity ProjectConnectivity Project

WICI T l ill t tiWICI ‐ Telco illustration 

26

WICI T l ill t tiWICI ‐ Telco illustration 

27

WICI Telco illustrationWICI ‐ Telco illustration 

28

KPIs taxonomies for sectors• Electronic components (WICI Japan) Pharmaceutical (WICI Japan)• Pharmaceutical (WICI Japan)

• Automotive/automobile (WICI Japan) T l i ti  (WICI E    EFFAS CIC)• Telecommunications (WICI Europe + EFFAS CIC)

• Software & IT services (EBRC + Gartner)Mi i   d E t ti (EBRC   G t )• Mining and Extractive (EBRC + Gartner)

• Fashion & Luxury (WICI Europe +WICI Italy)El t i it  (WICI E    WICI It l )• Electricity (WICI Europe + WICI Italy)

Available for free download in the WICI website Available for free download in the WICI website (www.wici‐global.com)

C l i Th Q tiConclusions – Three Questions• Are Luxembourg and its stakeholders willing toparticipate in the identification and development of thenew measures and metrics (KPIs/KRIs) for theIntangibles/Knowledge‐based Economy ?

• If yes, are Luxembourg stakeholders willing to join thei t ti l i iti ti d t ib t t th iinternational initiatives and contribute to the ongoingprocesses ?

• If yes, are Luxembourg stakeholders willing to set upWICI Luxembourg – with the assistance of WICIWICI Luxembourg with the assistance of WICIEurope – to foster and participate in these processes ?

Th k !Thank you !

For more information

WICI – Europe: zmbsfn@unife.it

WICI  Luxembourg : anne laure mention@tudor lu WICI – Luxembourg : anne‐laure.mention@tudor.lu