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ASIAN ACADEMY of MANAGEMENT JOURNAL of ACCOUNTING and FINANCE AAMJAF, Vol. 5, No. 1, 1 29, 2009 OWNERSHIP STRUCTURE AND INTELLECTUAL CAPITAL PERFORMANCE IN MALAYSIA Norman Mohd Saleh 1*, Mara Ridhuan Che Abdul Rahman 2 and Mohamat Sabri Hassan 2 1 Graduate School of Business, 2 School of Accounting, Faculty of Economics and Business, Universiti Kebangsaan Malaysia, UKM Bangi, Selangor, Malaysia * Corresponding author: ABSTRACT The performance of intellectual capital (IC) depends on the efficiency of investments in tangible and intangible resources devoted to value creation activities. The performance of IC investments is important because it affects a company's long term competitive advantage. This paper examines whether ownership structure (whether it is management, foreign, government or family ownership) can explain the variation in a company's IC performance. It provides additional insight into the role and incentives of firm owners and could affect the company's ability to increase value (value creation activities). This research relies on an empirical model using VAIC TM to measure IC performance. The data consists of all companies listed on the Malaysian Exchange of Securities Dealing and Automated Quotation Market (MESDAQ) market in between 2005 and Family ownership appears to have a negative effect on IC performance. A high degree of family ownership implies a high probability of opportunistic behaviour among families pursuing their objectives at the expense of value creation activities. The results are valuable for capital market regulators in monitoring the efficiency of value creation investments. Keywords: Foreign ownership, government ownership, management ownership, intellectual capital performance, Malaysia INTRODUCTION The emergence of a knowledge-based economy has changed the corporate nature of work. There are changes in the value of corporate performance parameters, as well as their perception. In this century, business communities across the globe agree that knowledge assets are becoming more critical to the corporate value creation process than physical production factors. This is particularly true for knowledge-intensive sectors, such as information technology. Unfortunately, 1 Norman Mohd Saleh et al. traditional accounting conventions are unable to accommodate the need to report knowledge assets. Thus, this phenomenon has created a significant disparity between a company's market and book values. As many researchers have noted, the large gap between a company's book and market values results from failures to report some 'hidden value' in the annual report (Brennan & Connell, 2000; Mouritsen, Bukh & Marr, 2004a). One could argue that this gap reflects excessive speculations by market players. However, in the long run, the discrepancy between market value and book value may be better explained by the change in the sources of value creation as economies have moved from tangible assets to intellectual capital (IC). 1 Assessing the performance of IC is important because it measures the efficiency of value creation activities, which is not reflected in financial statements under the traditional reporting system. In this study, IC performance is broadly defined as the efficiency of investments in resources in generating value. IC is an essential resource for corporate success in a knowledge economy. As Malaysia moves towards such an economy, there are an increasing number of technology companies. As of December 2007, there were nearly two thousand companies (1,994 companies) established in the Multimedia Super Corridor (MSC), Cyberjaya. These companies attract foreign and domestic investment in the form of share ownership. 2 According to agency theory, the separation of ownership and control may induce conflicting incentives, leading to agency costs (Jensen & Meckling, 1976). Consistent with this view, we believe that ownership types could, to some extent, determine the performance of investments in IC. Previous research suggests that the ownership structure has a significant effect on a company's efficiency and performance (Bonin, Hasan & Wachtel, 2005; Ng, Yuce & Chena, 2009; Xu, Pan, Wu & Yim, 2006). This is particularly important in the Malaysian context. Claessens, Djankov and Lang (2000) classified Malaysia as having concentrated ownership, in the form of significant family ownership and interlocking business relationships. These types of ownership and control may induce conflicting managerial incentives, namely, whether to create more value 1 To date, there is no universal or generally accepted definition of IC. Nevertheless, most of the definitions capture a similar meaning, in which IC is regarded as a source for long-term value creation. According to Edvinsson and Malone (1997), IC is information and knowledge applied to work for value creation. This definition is also consistent with Marr, Schiuma and Neely (2004: 552), who define IC as fundamental strategic levers to manage a company s performance and continuous innovation. 2 The MSC was formally established in Malaysia in It intends to be a dynamic ICT hub that houses institutions with activities on multimedia and communications products, solutions, services and research and development. 2 Ownership Structure and Intellectual Capital Performance for the company or to maximise self-interest. This context differs from a Western context, where companies have well-dispersed ownership structures and face high levels of investor activism. In addition, significant state ownership may have detrimental effects on a company's value creation activities, as the influence of the state may change the focus of the company away from creating shareholder value and toward fulfilling social and/or political obligations (Ahmad, 2008). It is important to determine the efficiency of IC investments as well as to explore the possible factors contributing to or limiting IC performance. This study attempts to measure IC performance at the company level using the Value Added Intellectual Capital Coefficient (VAIC ), a measure developed by Pulic (1998, 2000), and also to test whether ownership structure explains the variation in IC performance for companies listed on the MESDAQ market. 3 This market was chosen because IC performance is critical in technology-based companies. This study considers only listed companies because we can measure public accountability with regards to the performance. We selected 264 observations with complete data between 2005 and We predict that certain attributes of ownership structure will reduce or increase agency costs, in turn leading to better IC performance, as indicated by VAIC TM. Demsetz and Villalonga (2001) and Henry (2009) suggest that corporate governance and performance may have reverse causality or dynamic dependence problems. Thus, we employ the generalised method of moments (GMM) to address potential endogeneity problems between corporate ownership variables and IC performance. The regression results suggest that family ownership is negatively related to IC performance. This finding is supported by a two-stage-least square (2SLS) regression. Some studies have investigated IC performance and its relationships to board structure (Ho & Williams, 2003) and company performance (Gan & Saleh, 2008). However, our review of the literature suggests that this is the first study to investigate the relationship between IC performance and ownership structure. Investigating IC performance is more significant than other accounting or market-based performance measures because IC performance accounts for the performance of tangible as well as knowledge assets in creating value. From a time perspective, the accounting profit rate is backward-looking, while Tobin's Q is forward-looking and driven by historical accounting numbers as well as a multitude of world events and business strategies affecting investors' forecasts (Demsetz & Villalonga, 2001). We view the ownership structure as it influences IC performance through representation in the board of directors (which is indirect in nature). However, an 3 MESDAQ is a specialised market for technology-based and/or high-growth companies. 3 Norman Mohd Saleh et al. examination of the factors influencing IC performance may be incomplete without looking at the parties behind the board members. These parties may provide incentives to improve IC performance or otherwise. This study aims to provide additional insights into the role and incentives of the company owners. The next section discusses the Malaysian institutional background and the MESDAQ market. The third section discusses the literature and empirical predictions. This is followed by a section that describes the methodology. Section five presents the results, and the final section concludes. THE MESDAQ MARKET AND THE REPORTING ENVIRONMENT IN MALAYSIA The MESDAQ (Malaysian Exchange of Securities Dealing and Automated Quotation) market was launched in The objective is to provide a suitable avenue for high growth technology-based Malaysian companies to raise capital as an alternative to bank funding. The market includes companies operating in advanced electronics, information technology, telecommunications, automation manufacturing systems, biotechnology and genetic engineering, healthcare, advanced material, energy, aerospace, transportation and other emerging technologies. However, a clause in the listing requirements stipulates that any companies with high-growth business activities can be listed on the MESDAQ market. Within 10 years, the market has grown from five companies to more than one hundred. Differing from the Main and Second Boards of Bursa Malaysia, the IPO guidelines focus more on qualitative factors, since the companies are relatively young (with high growth potential) and lack established profit track records. 4 The qualitative factors include convincing business plans and models, growth prospects, the strength and integrity of the management, corporate governance mechanisms, and risk management structure and activities. These factors are evaluated for their ability to secure the long term viability of the business and sustain earnings (Securities Commission, 2005). Companies meeting these criteria can be considered for market listings. MESDAQ-listed companies must adhere to the accounting standards approved by the Malaysian Accounting Standards Board (MESDAQ Listing 4 Bursa Malaysia was previously known as the Kuala Lumpur Stock Exchange. The Main board refers to a board with larger sized companies that meet more stringent listing requirements compared to the Second board of the exchange. Starting on 3 August 2009, Bursa Malaysia implemented a new board structure. The Main and Second board were merged to become a unified board known as the Main Market, while the MESDAQ market were restructured and renamed as the ACE market. The new ACE market now focuses on emerging companies of all sizes and sectors. 4 Ownership Structure and Intellectual Capital Performance Requirement, 2001). This board requires that material information be disclosed to the respective exchange, in the form of a quarterly report and an annual report. In summary, financial reporting is guided by standards adopted from IFRS. Locally, these standards are known as the Financial Reporting Standard (FRS) by the Malaysian Accounting Standard Board (MASB), the accounting standardsetting body in Malaysia. The Bursa Malaysia and the Securities Commission require mandatory compliance with the approved standards. While compliance with approved accounting standards is mandatory, companies may send voluntary signals about their activities and performance using private information. Voluntary disclosure is expected to improve users' perception about the underlying economic value and performance of companies. Since the financial reports focus more on the financial results of the companies, additional disclosures in technology-related companies are expected to provide information on the value creation process and results or IC. The financial results, together with a description of IC, would enhance the investors' ability to make informed decisions about their investments. However, a formal investigation into voluntary IC disclosures is beyond the scope of this paper. LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT Understanding the role of IC in creating value is crucial for attaining a competitive advantage in the marketplace and superior financial performance (Drucker, 1995; Marr & Schiuma, 2003). However, there are few appropriate measures of a company's IC (Chen, Shevlin & Tong, 2005). Thus, the failure to identify, measure and understand the value of relevant IC components may lead to inefficient investment decisions. The collapse of Marconi in the UK and that of Enron in the US provide the best examples of how a sudden switch in corporate value from heavy dependence on tangible assets (Enron in physical energy production and Marconi in electrical goods and defence) to a company that possesses significant intellectual assets contributed to confusion among analysts and investors (CIMA, 2000). There is no universal classification for IC. Prior research has relied on its own classification, such as Scandia Navigator (Edvinsson & Malone, 1997), Balance Score Card (Kaplan & Norton, 1996), Intangible Assets Monitor (Sveiby, 1997), Value Chain Score Card (Lev, 2001), Value Platform (Petrash, 1996) and many others. These IC classifications differ, and some are quite complicated. However, the literature suggests that IC can be classified into three common categories: (i) human capital; (ii) internal structure (i.e., organisational capital); and (iii) external capital (relational capital). 5 Norman Mohd Saleh et al. Human capital is the knowledge that employees take with them when they leave the organisation. Knowledge can be unique or generic. It includes innovation, flexibility, tolerance for ambiguity, motivation, satisfaction, learning capacity, loyalty and formal training and education (CIMA, 2000), know how, education, vocational qualification, work-related knowledge and entrepreneurial spirit (Brennan & Torous, 1999). The knowledge that employees embody can be formalised through patents, copyright and brands (Meer-Kooistra & Zjilstra, 2001). Bontis et al. (2000) argued that human capital is important because it is a source of innovation and strategic renewal. On the other hand, internal structure or organisational capital is knowledge independent of people. It can be defined as the knowledge that stays in the organisation. Examples include intellectual property, contracts, databases, information, systems, cultures, procedures, manual, administrative system, routines and best practices (CIMA, 2000; Brennan & Connell, 2000; Bontis, Keow & Richardson, 2000; Edvinsson & Malone, 1997). According to Bontis (1998), IC will not reach its full potential if an organisation has poor systems and procedures. The third component of intellectual capital is external structure. External structure (also known as relational capital) is defined as valuable knowledge that interacts with the external sources of the organisation (such as customers, suppliers and creditors) through networks, strategic alliances and distribution channels (Bozzolan, Favotto & Ricerri, 2003; Sveiby, 1997). These external sources contribute to image, reputation, customer loyalty, commercial power, and negotiating capacity with financial entities and environmental activities (CIMA, 2000). Given the drawbacks of traditional financial statements and the increasing gaps between market and book values, how to measure and manage a company's IC value and performance has drawn attention from various parties. These studies include an individual company's tool kits for internal use, also known as non-dollar valuations of the IC model (Tan, Plowman & Hancock, 2007), such as Balance Scorecard, Performance Prism, Ericsson's Cockpit Communicator, Skandia Navigator and Sveiby's Intangibles Asset Monitor Approach. Another stream of research has developed several approaches for estimating the value of IC using financial statement data. This is known as the dollar valuation model (Tan et al., 2007). These approaches allow external parties or stakeholders to estimate a company's value of intellectual capital using publicly available information, such as an annual report. These include the EVA and MVA models (Bontis, Dragonetti, Jacobsen & Roos, 1999), Tobin's Q 6 Ownership Structure and Intellectual Capital Performance (Tobin, 1969), Calculated Intangible Value (Stewart, 1997), Matching Assets to Earnings (Lev, 2001), Value Added Intellectual Capital Coefficient (Pulic, 1998) and many others. In this study, we employ the VAIC methodology to measure IC performance because it measures the efficiency of a company's value creation activities. 5 East Asian IC Performance Studies The VAIC method has been applied across industries and in many countries. For example, Williams (2001) investigates the relationship between IC disclosure and its performance in the UK; Firer and Williams (2003) examine the association between IC performance and traditional corporate performance in South Africa; and Chen et al. (2005) test the relationship between IC performance and companies' market value and financial performance in Taiwan. Tan et al. (2007) examine a similar issue in Singapore: determining the relationship between IC performance and financial return. It is also interesting to note that the banking sector is found to be a central concern of VAIC studies, as the sector is considered to be knowledge-inclined (e.g., Mavridis, 2004, 2005; Goh, 2005; Kamath, 2007; Yalama & Coskun, 2007). Goh (2005) and Cheuk, Wong and Kok (2006) have studied IC performance in Malaysia. Goh (2005) aims to measure the IC performance of ten local and six foreign commercial banks between 2001 and The study finds that about 80% of the value creation capability (VAIC value) of both domestic and foreign banks is largely attributed to human capital efficiency (HC), as opposed to structural capital efficiency (SC) and capital employed efficiency (CE). As expected, foreign banks are more efficient than domestic banks. Cheuk et al. (2006) investigate VAIC data from 52 public finance companies from the Bursa Malaysia. Their study examines the explanatory power of VAIC towards the companies' market value, where market value is denoted by share prices. The results show that the correlation between VAIC and share price is negative. In addition, regression analysis indicates that VAIC has no explanatory power in predicting market valuation. Recent findings can be drawn from Kamath (2007) and Tan et al. (2007). Kamath (2007) for example, observes the IC performance of 98 Indian Banks from various groups between 2000 and The mean VAIC score over this five-year period is only about 3.6 in 2000 and 4.1 in 2005, lower than the VAIC figure reported by the Malaysian banking sector (Goh, 2005). It appears that most large foreign banks in India are among the top performers, while the performance of domestic banks is worse. 5 More details on VAIC can be found in the research methodology section. 7 Norman Mohd Saleh et al. Tan et al. (2007) examine 150 publicly listed companies of the Singapore Exchange between 2000 and 2002, testing the relationship between the VAIC and companies' performance as denoted by ROE, EPS and ASR. The results can be summarised as follows. First, there is a significant relationship between VAIC and companies' performance. Second, the VAIC is positively related to a company's future performance. Third, the growth of the VAIC is weakly correlated with a company's performance, and the VAIC is higher in service and property sectors relative to the trading sector. The literature suggests that IC performance is related to demographic characteristics of the company, suc
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