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Federal State Educational Institution Of Higher Education

National Research University

Higher School Of Economics

Saint Petersburg School of Economics and Management

Department of Management

Bachelor's thesis

In the field 38.03.02 `Management'

Educational programme `Management'

Influence of Intangible Assets on Market Capitalization of a Public Interest Entity from Russia

Vladislav Kovalevskiy

Saint Petersburg 2019

Abstract

This bachelor thesis is based on studying of intangible assets value influence on company market capitalization. Problem of research is that now it is difficult to valuate role of IA on company market value. To solve this problem, this research aimed to conduct an analysis which will show how IA impact on company market valuation. Moreover, there is a lack of actual researches in field of intangible assets influence on market capitalization of PIEs on Russian market. Thereby, in frames of this research, correlation and regression analyses will be conducted to confirm or reject stated hypotheses. It is expected from this work to make a significant contribution in management sphere in terms of value-based management by examination of intangibles as factor of increasing market value of company.

Introduction

For understanding the key essence Intangible Assets there were described its different definitions by different scientists, boards and organizations. Also, there were observed existing criteria for recognition of Intangibles for conceptual understanding such type of assets. Views of aforementioned scientists and boards differed for a little from each other, but contained common characteristic, which were highlighted and then combined into general definition of Intangible Assets. After defining the concepts, were observed existing classifications of Intangibles and their explanations. Next important step will be to study interpretations of Intangibles according to accounting standards.

Intangible Assets and accounting standards

After defining an essence of Intangibles, it will be useful to explore methodologies of their accounting, identification problems in IFRS (International Financial Reporting System), RAS (Russian Accounting Principles) and US GAAP (United States Generally Accepted Accounting Principles). Different approaches of accounting can lead to different effects of financial statements. Knowledge about the differences will help to more precisely understand the way Intangibles become on balance and which subtext carries one or another accounting standard.

IFRS approach of recognizing and accounting of Intangibles is corresponding with IAS 38 "Intangible assets". According to International Accounting Standards Intangible assets are non-monetary assets which are without physical substance and identifiable either being separable or arising from contractual or other legal rights (IAS 38, 2004). In appliance with IAS 38 any asset is a kind resource which implies such criteria: 1) It is under control of company; 2) It is expected to get future economic benefits. Besides these criteria, intangible asset should have a sing of identification to recognize it in financial statements like separate asset. Identification of an Intangible asset is possible, if such criteria are met:

· Intangible asset could be separated from company and its assets structure and then be defended by license agreement, be sold, be transferred to other company, rented out, exchanged individually or in complex with linked contract, asset or liability. These conditions should be possible to be completed either company is planning to that or not.

· Intangible assets are represented as a result of contractual, legal or other types of rights. It does not matter is it possible to transfer these rights and separate them from company.

It is stated, that control of Intangible assets by company exists, if company is getting benefits from such asset or is confident about future benefit flows from such an asset. One more condition should be kept up: company is able to prevent getting benefits from this intangible asset from other companies. Usually this restriction is going from legal rights on such asset. Discoursing about benefits, it is important to say how they can be recognized. Benefits could origin from rise of earnings from sales and also benefits can become from cutting off costs. For example, earnings can grow up by getting exclusive rights on some type of production. Another point is benefit from implementation of new software because of decreasing costs for royalty payments.

In Russia intangible assets accounting is regulated by Tax Codex of Russian Federation and Accounting Statement 14/2007 "Accounting of intangible assets". Also, Intangibles are described in Civil Code of Russian Federation. In part 4 of Civil Code there are description of types of intangibles and also how legally can be protected these assets.

Definition of intangibles exists only in Tax Codex and can be formulated like: intangible assets are results of intellectual activities, which were bought or developed by taxpayers or other types of intellectual property, which are being used in production or service providing processes or for management needs of organization for a long-term perspective (duration is more than 12 months). According to Tax Codex of Russian Federation there could be highlighted these characteristics of intangibles:

· Availability of documents, which prove the fact of intangible asset existence or existence of exclusive rights for intellectual activities results (it can be license, patent or other document, which proves such legal rights)

· Availability of asset to bring benefits to possessor

In conformity with Accounting Statement 14/2007 there are also defined characteristics of intangible assets (Ministry of Finance of Russian Federation, 2007 (upd. 2016)):

· Asset does not have physical or material form

· Ability to separate an object from other assets and clearly identify it

· Company-owner has rights to receive benefits from using an intangible asset. It means that company has documents, which prove an asset existence and exclusive rights on result of intellectual activity

· Asset is able to bring economic benefits to organization further (it can be used for management needs or for production of goods and providing services)

· Asset has a long-term character of beneficial usage, to be more precise - more than 12 months or usual operational cycle, if this cycle is more than 12 months in duration

· Company does not have intensions to sell this asset during next 12 months or operational cycle, if it is longer than 12 months

· Factual price of an asset is able to be valuated precisely

Therefore, it is pointed out that RAS intangible asset recognition criteria also focused on temporary character. There is a crucial fact about RAS: non-exclusive rights are able to be intangible assets, but these ones are not able to be put on balance sheet of company. These examples of non-exclusive rights are franchising contract or license agreement. Only exclusive rights, protected by Russian Federation legislation, can be put on balance sheet. What more can be concluded about 14/2007, it has also list of objects, which could be identified as intangible assets:

· Business reputation of organization, which origins from acquisition of company like complex of property

· Intellectual property objects

As with list of objects, which can be identified like intangible assets, there also are some positions about things, which cannot be recognized like intangible assets. There are some common points between IFRS and RAS. One of the main are: skills of employees (it can be either technical skills or business skills, needed for work; also Research & Development results in case of non-positive in terms of usage and their implementation. Some more words about business reputation or, as like it is often called, goodwill. That is the fact that business reputation, which was developed internally in company, cannot be recognized as intangible assets. This affirmation is valid as for abroad legislations, as for Russian legislation. The differences from standard to standard, especially criteria of recognition, can lead to different effects of including intangible assets in balance sheet and company's overall assets structure. For example, the absence of mentions and law basis of some types of intangible assets in Russian legislation becomes a reason, which defines an impossibility to recognize these types of assets: rights to use limited access resources, broadcasting license agreement, etc. However, some opposite moments take place. For example, in accordance with IFRS, Goodwill cannot be an intangible asset. The explanation of such statement is simple - goodwill does not match identification criterion. In RAS another position about Goodwill exists - in case of buying company's property complex Goodwill appears and then it should be recognized and should be put in balance sheet.

This paragraph is about US GAAP and its approach to intangible assets accounting. US GAAP focuses on FASB methodology implementations. There are standards ASC 350 "Goodwill and other intangible assets", ASC 730 "Accounting of costs of research and development activities" and others. These standards define intangibles as assets, which do not have physical form. US GAAP uses the same criteria for recognition of intangible assets, as IFRS uses. There could be concluded that fewer amount of differences between US GAAP and IFRS in case of intangibles is better for understanding USA businesses by foreign investors and, consequently, is able to attract more investors from other countries.

To make comparison more clear it is suggested a table of criteria of intangibles recognition. In the Table 1 (Belikova, 2017) there are observed criteria for Intangible Assets recognition according to accounting standards. Criteria for Intangibles in IFRS (International Financial Reporting Standards) and US GAAP (United States Generally Accepted Accounting Principles) are quite similar and have "+" points (which means "necessarily", also "-" means "not necessarily") only for non-material form and ability to bring economic benefits in future, while in RAS (Russian Accounting Standards) all criteria marked as "+". Based on information from table there could be generated an assumption that companies, which publish financial statement according IFRS an US GAAP on the one hand have wider specter of opportunities to include not yet recognized Intangible Asset in Total Assets structure, but on the other hand makes a process of recognizing Intangibles more complex because a lack of precise criteria. Companies which are publishing financial statement according to RAS on the one hand have more concrete criteria for Intangibles, but on the other hand more restrictions for recognizing Intangible assets in company assets structure. It can result in missing the clear understanding of company assets structure.

Table 1. Comparison of criteria for Intangible Assets due to accounting standard Source: (Belikova, 2017)

In RAS there are too much details and boundaries linked with criteria of identification and recognition of intangible assets and it has respectively effects. For example, according to AS 14/2007 intangible asset should be used by organization in period of 12 months or more, otherwise such asset will not be recognized as intangible asset. In US GAAP intangible assets utilization period can be shorter than 12 months. (Bashkatov & Dagarguliya, 2014) Why is it important? In IAS 38 definition of intangibles is much wider, what is opposite to definition from Tax Codex of Russia. It has positive influence for companies, which present IFRS financial statements, on such fact like possibility to recognize more intangibles and their economic essence. Therefore, such companies can saturate their assets structure by adding some more types of intangibles.

Here the problem of this research is addressed again. The situation of differences between concepts of intangible assets in accounting standards makes a problem of investors perception of company and consequently to less weighted financial decisions (because of lack of relevant information about structure of intangible assets in assets structure of company). In accordance of this issue, it was studied a research of CIMA and Brand Finance, which concludes, that companies with the highest disclosure of intangible assets are from European Union on the moment of research (CIMA; Brand Finance, 2015) It makes possible to judge, that Russian companies recognize intangibles in fewer scale. And this fact bothers investors to see the real picture of financial conditions of Russian companies. If it concluded only on research result - it is mistake, but his fact can also be empowered by previous description of approach to accounting intangibles in Russia. Also, this fact can distort such picture for company's management core and will lead to not correct way of assets management.

There was mention of investors perception of intangibles (or it could be taken more generally - financial condition of company). It should be described in more details due its importance. Recognition of intangible assets will lead to increase in company's assets, and therefore in company's equity. It leads to perception of company financial state less risky and more stable. In case of other condition remain neutral it also can lead to better index of financial leverage, what also considers more stable position.

Examples of intangible assets are patented technology, trademarks, trade secrets, internet domains, licensing, royalty and standstill agreements. There are also some other types of intangible assets. The crucial point is that reflection of intangible assets in the balance sheet of the company can vary depending on standards of financial reporting in each country.

Therefore, it could be concluded in such case that differences and discrepancies can exist from country to country because of accounting standards. For making this research more concrete, it was stated to define which accounting standards are being used for companies observed, so this research paper it was chosen IFRS accounting standards. However, knowledge of the essence of intangible assets is not sufficient to understand whole idea of research, because the research topic is about influence of intangible assets on market capitalization of Public Interest Entities (PIEs). EY in its periodical report mentioned that share of intangible assets of companies was grown from 17% in 1975 to 84% in 2015 (EY, 2018). Therefore, it is crucial to figure out the role of Intangible Assets in creating a company's value and this working paper aimed to do that. To reveal aforementioned and to show actual point of view of academic society some existing research papers and academic works were chosen to be analyzed in current work.

Company's value and value-based management

Nowadays there is an era of market economy. Such prerequisites like privatization, commercial landing, an emergence of stock market lead to implementation of new approach of companies' value estimation. However, before definition of company value it is better to explain why it is important to know. In this work focus on estimation of influence of intangible assets on market capitalization. Why is it important to know that? Why market capitalization matters? For business its value is a kind of indicator of how it works: successfully or not and how one business can be compared with others. Developed countries experience defines key target for companies, which want to flourish in the long run - to maximize their value. (Raush, 2009)

Today the tendency of transition to the Value Based Management concept exists. Value Based Management is a management concept, which is targeted on development of quality of operational and strategic decisions, based on focusing efforts on key value drivers, which lead to company value growth. The main task for owner or top manager of business is development of company liquid value and also creation of system of managing company's value with the long-run objective of its maximization. In accordance with aforementioned concept, the market value of company is the highest monetary price, which could be got from company property sell on competitive and opened market with completion of conditions of justified deal. What also matters, it is buyer and seller rational approach to deal and there are no other external affective factors and incentives. What are the main advantages of company market price? Firstly, its valuation helps to buyers and sellers to make a deal, taking into attention reasonable value of product, good or even a whole company, because market value takes into account not only individual characteristics of object of deal, but also market conditions like market expectations, general economic trends and market sensitivity on such deal completion. Market value estimation helps to detect company's equity value and its whole market capitalization.

Secondly, estimation of company's value allows to define the market value of the equity and capitalization, in general. Thirdly, awareness of the market value gives to the owner an opportunity to refine the production process, investigate complex of actions, aimed at increasing of enterprise market value. Periodically pursued valuation of company's market price enables to increase management efficiency, and, as the result, to reduce the probability of bankruptcy.

In comparison with other indicators, such as income, profit, profitability, enterprise value has several significant benefits. Firstly, its valuation requires complete information, and moreover the knowledge and experience of managing all cash flows. Secondly, the market value of the company allows to achieve more reliable and accurate compromises, since the operation of any participant can be valued. Thirdly, shareholders have a strong incentive to control and managed company resources. By maximizing their own welfare, they at the same time facilitate to the wealth of others.

If the indicators such as profit and market value are compared, the profit of the enterprise shows the level of efficiency of its work in the current period. The market value presents not only the current moment, but also the prediction about particular company, assessment of its ability to generate and increase profit. From this point of view, company's value more accurately reflects long-term business perspectives.

In addition, it is necessary to remember that there is constant competition between competitors for one main resource - the capital of investors. And if the company cannot provide an appropriate value growth, the threat, which is related to the loss of significant resources, will increase. Therefore, the implementation and use of indicators in management, which are oriented to increase the business value, becomes a necessary technique nowadays.

Nowadays, in the terms of high level of financial markets development and increased competition for resources, the theory of market value as the main indicator, which is the base in value-based management, is becoming more common. There are several opinions about what the main goal of the company is. Moreover, on different vital stages companies set different goals. According to existing firm's theory, the possible indicators for maximizing are sales volume, profit, assets growth rate, welfare of shareholders.

Owners of the company and investors can get the profit in two ways: current income or dividends; via growth of the company's market value. What way of getting income is more valuable and significant for the company?

The growth of market value of the enterprise has a great advantage over the dividends. Dividend payout is always limited: it cannot exceed the profit of the previous year, while the limit of growth of the company's market value does not exist. The maximizing of the company's value was offered as the fundamental goal of the companies by A. Rappoport and B. Stuart in the early 90s of the 20th century. Therefore, it leaded to emergence of new ideology in management theory - value-based approach. (Tonkyh, 2010)

This concept represents "universal widespread management system, which, according to A. Rappoport, includes 4 core elements: assessment, strategy, finance and corporate governance.

"Strategy" measures corporate business strategies directed to goal's achievement - increasing enterprise value for its ownership. Therefore, value-based concept can be presented as the independent direction of strategic management.

"Assessment" includes choosing a model and process of determining company's value for their owners, monitoring of value's changes, defining tools for creating new value.

"Corporate governance" is aimed to accord interests of owners and management and motivate employees' operation, the goal of which is creation of shareholder value.

"Finance". At this level factors, which generate value, are defined. From the variety of factors, key ones for particular divisions and for the whole corporation in general are emphasized. Value of the company can be created only when income from investments outreach the cost of invested capital.

Data that is used for assessment of company's market value should accurately and completely reflect the business situation, results and conclusion should be based on correct and reliable calculations. To decrease the possibility of misrepresentation and manipulation of such data, accounting statements, made in accordance to international standards and monitored by auditors, should be used.

In the end of the 1990s, several researches were conducted, which convinced that companies, which use methods of value-based approach, have competitive advantages over the other companies. In the April - May of 2010 year KPMG company with National Research University Higher School of Economics conducted a study among the biggest Russian companies. In pursued survey 25% of managers assert about complete using of techniques of value-based concept, more than a half of managers implement methods of this approach partly, which means orientation on value maximization in strategic and operation management. More than 75% of managers are sure that company's value is the fundamental indicator during decision process. (KPMG, 2010)

In the research the comparison of financial indicators of companies that implemented value-based methods and average market financial indicators was conducted. It was noticed that such companies, used value-based methods, go on par with the market, or, most often, ahead of it. At the same time, financial results of companies that do not implement this concept are significantly lower, especially indicator of economic profit.

According to this research, the main initiators of value-based concept implementation are shareholders, "this is due to the high degree of transparency and manageability that can give shareholders the full use of such management systems". (KPMG, 2010) Key factor of successful integration the concepts of value-based approach is reliable and active support of top management.

It is necessary to indicate the components which generate the company's market value. Two aggregate components of company's value can be emphasized: fundamental parameters and the efficiency of corporate governance. (Belikova, 2017)

Among fundamental factors following can be highlighted:

* Indicators of operational performance (sales growth rate, sales profitability)

* Indicators of investing performance

* Indicators of financial performance (return on assets and equity, WACC)

These components of value creation, during interaction, lead to results expressed by specific financial indicators. Using of these components also leads to formation of competitive advantages.

The problem of key factors of company's value creation worries many researchers. The lack of unambiguity in this question is a serious disadvantage of the value-based concept and requires additional research. Such authors as T. Koller, T. Copeland and J. Murrin as the intrinsic value of a company consider "the discounted cash flow value that determines the specific investment opportunities of the company. However, the authors indicate the limitation - since this criterion is determined on the basis of forecasts, it is not applicable to the assessment of past results. In addition, the forecasting of future results always assumes probability and uncertainty, and management of the company based on such data will create greater differences in the valuation of the company by different investors. Therefore, the additional criterion of company's value is required for the management and owners of the company. (Belikova, 2017)

In order to increase the company's value, it is necessary to emphasize key factors, which influence it. Economic base of the growth of company's value is its complete resource capital - all assets, held by the company and capable to generate income. It is necessary to emphasize that along with tangible assets, intangible assets are becoming increasingly important. Using of intangible assets can become an integral part of the company's value increasing.

Previous studies

Some scientists and researchers also studied Intangible assets and their influence on company value and some financial indicators. (Kovalevskiy, 2019) During the studying academic sources was found Doctoral dissertation from Lithuania in the same field, but about Lithuanian companies. According to this dissertation, value of Intangibles have positive correlation with company market value. The results showed that general value of Intangible Assets growth of 1 percent increase 0,249 percent the market value of companies. In addition, these results showed that impact of IA value on company market capitalization is more intensive in the manufacturing sector than in the service sector. (Buюinskienл, 2017)

In other work from researchers from New York Pace University the brand is being studied like intangible asset of firm. This research suggest that brand value impacts on share price of company. Brand valuation relationships with stock prices are found to be significant. However, writers considered that brand and share price relationship is moderated by a firm type, and although the association of brand value and stock prices is significant for consumer firms, it is not significant for industrial firms. (Kirk, Ray, & Wilson, 2013)

In difference of two previous works next research is about pharmaceuticals companies in Jordan. In research topic emphasized that work will be about Intangible assets which were generated by company internally. The results investigated show that investments which are aimed at intangible assets lead to maximization of the market value of Jordanian pharmaceutical companies (Jaara & Khalid, 2016). It is important for pharmaceutical companies the main intangible asset is a patent (patent for new drug). In addition, this shown that maintaining confidentiality about patents manufacturing helps to maintain the competitive position for pharmaceutical company.

Moreover, there is one more work in the same field about relationship between Intangible assets and market value of companies in metals industry. These companies are being traded on Tehran stock exchange. Behname, Reza Pajoohi & Ghahramanizady give attention to Intangible Assets as creators of value for productive companies. However, there are some challenges for right measuring and reporting of IA share in firms due to specifics in local accounting standards. Regression analysis and other tests were provided to analyze data from 2001 to 2011. Test results showed that reported Intangibles have strong positive relations with market value of aforementioned companies. It means that increase in IA leads to increasing company market value in metals industry (Behname, Reza Pajoohi, & Ghahramanizady, 2012).

There also research exist, where authors explored the intangible assets and their role in company market and financial performance as for present moment as for future. These companies are included in FTSE 150 with the time range of presence of these companies from 1995 to 2015. The main focus of this research was on R&D and Goodwill role on performance of companies. Authors used such indicators like ROE and ROA for valuation the effect of investments in intangible assets on company future performance and financial conditions. As a result of this study was the conclusion that such investments have positive impact, but only for long-term focus. The opposite relationship was for short-term orientation. Generally, this study showed, that Intangible assets of firm is an important factor for positive future performance of company, what makes investments in IA the fundamental factor, which should be taken into attention by management of companies. (Tahat, Ahmed, & Alhadab, 2017)

One more study was focused on intangible assets and their influence on company present value and its options for further growth. There is a one important detail - intangible assets were taken without goodwill. This work shows that there is a positive relationship between intangible assets recognized and companies' options for growth. Moreover, as a complementary part of this research was also showed, that companies' growth options have positive relationship with level of disclosure of intangible assets. The data for this research was taken for United States firms, which are publicly traded on exchange from 1976 to 2010. (Makrominas, 2017)

The research that was completed by (Bridgman, 2014) was studying the investments in intangible assets of companies from the USA, which are mentioned like the most influential multinational companies, through 1994 to 2010. This work does not make a focus on such intangibles like organizational capital or trade secrets. The final results of work showed that intangible assets is a very important point for companies and it should be a focus for building strategies for firms.

There also was a study about intangible assets implication on companies which are holding returns. It was supposed that intangible assets have positive and significant impact on such returns. (Heiens, Magrath, & Leach, 2007) However, it was pointed out that high level of expenditures on Research & Development purposes has negative effect on returns of shareholders what was also confirmed in (Tahat, Ahmed, & Alhadab, 2017) work further. The data for this research was compiled from information for more than 1.6 thousand companies for 2001. Opposite to short-term negative impact on shareholders' return by investing in IA, intangible assets have a positive relationship with stockholders' returns in general way. It means that the more intangibles company has, the more returns for shareholders it generates. It was also mentioned that intangible assets linked with advertising activities of the company have also impact, that leads to increasing of returns for long-term perspective.

There are also more concrete works, that studied intangible assets influence on companies' market value. For example, one of such works belongs to (Belem & Marques, 2012). These persons researched market expectations about company performance, which are not explained by recognized amount of intangible assets. As a result of research, it was discovered that degree of intangibility of company has positive relationship with its return on equity. In research of (Bakar, Salamudin, Hassan, & Ibrakim, 2010) there was an investigation of effect of intangible assets and company market value. There was used multiple regression model. The dependent variable was a company market value and explanatory variables were net income and net assets, which were divided by revenue.

Continuing with researches, it is also should be cited the work of (Sinclane & Keller, 2014) In this works authors affirmed that firm market value becomes the more dependent on Intangible Assets and that tangible assets lose their significance in comparison with intangibles. In last years intangible assets became more useful and relevant for companies and the are have special significance for technological companies. It is stated that intangibles' ability to create value by using more knowledge resources and work with company brand promotion.

Upcoming research is considered to be the key reference point for current working paper, because it is about Russian companies being traded under RTSI index. But this work not so actual, because focused on companies' data from 2001 to 2006. In this work were compared fundamental value of tangible and intangible assets influence on company market capitalization. Authors divided companies from sample on five industries and valuated influence of TA and IA on each one. This working paper concluded that for Russian market for respective period of time tangible assets have more significant role in company value creation, than Intangible Assets (Volkov & Garanina, 2008). However, this research does not take into account today accretion of intangible assets since 2008 (what is being confirmed by trend of IA growth mentioned above). Therefore, it would be science interest to compare how actual market situation changed or not according to work of Volkov & Garanina.

It is considered, that for companies their tangible assets are not stated as sources of sustainability of competitive advantage. One of the reasons for it that they can be generated and duplicated in more simple way, than intangible assets. (Carmeli, 2001) Researchers generally tend to give more attention and appreciation of intangible assets and benefits it can create. Such assets can generate competitive advantages to firms. Moreover, intangibles take a crucial position in business planning. Furthermore, most of works cited in current research confirm positive role of intangible assets in business developing and gaining returns for shareholders and company market value generally. However, these works are from different countries and mostly concentrated on different economic sectors. In this way, current working paper will fill the gap by researching actual information about role of intangible assets in creating market value of public companies from Russia. Actualization is very important, because economic development and economic situation from last work about Russian companies really changed and value of Intangible assets for business changed too

Methodology and data

In this part of work will be represented such moments like data collection and compiling a sample for research, it would be a justification of variables list compilation. Moreover, it will be described a method of analysis and final model, which will represent how intangible assets value impacts on company market capitalization. There also will be explanation of obtained results.

Object of the study

Intangible assets are the object of this research paper, because theory and previous researchers stated its actuality and importance for business and its value growth. The subject of this work is Intangible assets influence on market capitalization of Russian company. The main target of this work is to add new knowledge to management sphere in terms of managing the intangible assets in company assets structure, and also to add knowledge to scientific society, which inspects intangible assets and their role in adding value to business. Therefore, it is important answer the question: "Does the influence of intangible assets book value on company market capitalization is significant?"