Intangibles and accounting structures in regulated industries: conceptual framework and practices Giuseppe Marzo University of Ferrara Innovation in Network Industries: Accounting, economic and regulatory implications Paris, 16 March 2011

Giuseppe Marzo Intangibles and accounting structures in regulated industries 2 Agenda Accounting for intangibles and the theory of the firm Accounting for Intangibles in five theories of the firm: a comparative analysis Accounting for intangibles in regulated industries: some introductory insights Concluding remarks

Giuseppe Marzo Intangibles and accounting structures in regulated industries 3 The basic framework Theory of the Firm Accountin g theory Intangible s

Giuseppe Marzo Intangibles and accounting structures in regulated industries 4 Research on intangibles-related issues Intangibles Competitive Advantage Value Creation Intangibles’ Valuation Reporting & Disclosure Management

Giuseppe Marzo Intangibles and accounting structures in regulated industries 5 The problem: A lack of internal coherence in the research on intangibles Intangibles Competitive Advantage Value Creation Intangibles’ Valuation Reporting & Disclosure Management Accounting standards for intangibles capitalisation fair-value accounting vs cost-based accounting The effect of disclosure on firm’s value How managing intangibles for competitive advantage Valuation models How intangibles sustain competitive advantage and value creation Who controls intangibles Intangibles’ definition Intangibles’ analysis

Giuseppe Marzo Intangibles and accounting structures in regulated industries 6 Goal of the paper 1. How different theories of the firm coherently shape research, accounting for and policy- making on intangibles 2. What implications for accounting for intangibles, with some special references to regulated industries

Giuseppe Marzo Intangibles and accounting structures in regulated industries 7 Five theories of the firm Economics-based theories of the firm  Theory of Agency Costs (Jensen and Meckling, 1976)  Property Rights Theory (Hart and Moore, 1990; Hart, 1995)  Transaction Cost Economics (Williamson, 1979, 1985, 1991a, 2002) Business Management theories of the firm  Resource-Based View of the Firm (Wernerfelt, 1984; Barney, 1986)  Dynamic-Capabilities Theory of the Firm (Nelson and Winter, 1982; Teece, 1987 and 2007; Teece, Pisano, Shuen, 1990 and 1997)

Giuseppe Marzo Intangibles and accounting structures in regulated industries 8 Theory of Agency Costs Overview  the firm is a nexus of contracts, a legal fiction  behaviour of the firm is like the behaviour of the market  firm without boundaries  focus on agency relationships  comprehensive contracts  perfect and complete markets Definition and identification of intangibles  related to individuals  embedded in agency contracts  separability of intangibles (as contracts) Recognition of intangibles  intangibles refer to single individuals  externally-originated intangibles Measurement and valuation of intangibles  fair-valued contracts  market-based models and the fair- value  the value of firm as sum of the value of contracts  focus on shareholders’ value  focus on fair-value-based balance sheet  Market-to-Book ratio is the result of bad accounting principles  reporting as a bonding activity

Giuseppe Marzo Intangibles and accounting structures in regulated industries 9 Property Rights Theory Overview  the firm is a collection of physical assets owned by the boss  ownership and the control over workers  the ex-ante distribution of property rights and the residual control rights  incomplete contracts Definition and identification of intangibles  related to individuals  separability of intangibles Recognition of intangibles  refer to single individuals  property rights well-defined but with some ambiguities Measurement and valuation of intangibles  intangibles market-based models  private benefits extracted by workers vs surplus exploited by the owner of the firm  focus on balance-sheet  Market-to-Book ratio is the result of property rights distribution and expropriation

Giuseppe Marzo Intangibles and accounting structures in regulated industries 10 Transaction Cost Economics Overview  the firm is a governance structure of transactions maximising static efficiency  individuals are rationally-bounded and self-interested with guile  asset specificity, uncertainty, number of transactions Definition and identification of intangibles  individual learning-by-doing  the governance structure itself  separability of intangibles Recognition of intangibles  intangibles refer to single transactions  focus on externally-originated intangibles and on transaction-related intangibles  intangibles refer to the hierarchy Measurement and valuation of intangibles  Market-to-Book ratio depends on assets’ specificity and is the result of the superior efficiency of hierarchy over the market  focus on shareholders’ value  fair-value accounting vs cost-based accounting  focus on balance-sheet

Giuseppe Marzo Intangibles and accounting structures in regulated industries 11 Resource-Based View of the Firm Overview  firm as a cluster of acquired resources  the complete but imperfect Strategic Factors Markets  Ricardian rent through acquisition of resources at a lower-than-value cost  no accumulation process Definition and identification of intangibles  specific externally acquirable assets  separability of intangibles Recognition of intangibles  poor definition of property rights on intangibles  focus on externally-originated intangibles Measurement and valuation of intangibles  market-to-book ratio is not expressive of intangibles’ value, but of tangibles’ value also  no capitalization for internal generated intangible assets  focus on cost-based balance sheet

Giuseppe Marzo Intangibles and accounting structures in regulated industries 12 Dynamic-Capabilities Theory of the Firm Overview  the firm is a cluster of dynamic core competences and supporting assets  entrepreneurial rent  incomplete markets Definition and identification of intangibles  individual competences  organizational knowledge and competences  inter-firms knowledge Recognition of intangibles  poor definition  organizational knowledge embedded in social structures Measurement and valuation of intangibles  firm-specific models  capitalization for internally generated intangible assets  Market-to-Book ratio is expected to be greater than 1  focus on cost-based income statement

Giuseppe Marzo Intangibles and accounting structures in regulated industries 13 Accounting for Intangibles and five theories of the firm Theory of Agency Costs Property Rights Theory Transaction Cost Economics Resource-Based View of the Firm Dynamic-Capabilities Theory of the Firm separability of intangibles fair-value external generation inseparability of intangibles cost-based value internal generation economics theoriesbusiness management theories focus on market focus on entity focus on balance-sheet focus on income statement regulators and standard setters dynamic efficiencystatic efficiency

Giuseppe Marzo Intangibles and accounting structures in regulated industries 14 Intangibles in regulated industries: some introductory insights The inefficiency of functional separation schemes Defining standard costs  Focus on tangible assets  The neglecting of firm-specific intangibles  The capitalization of intangible assets Defining the opportunity cost of capital  The definition of the cost of capital rate: the market-based, fair- value approach and the shareholder focus  The Invested Capital: the role of unrecognized intangible assets

Giuseppe Marzo Intangibles and accounting structures in regulated industries 15 Final remarks and future research Different theories of the firm differently shape accounting for intangibles Accounting for intangibles and impact on decision- making in regulated industries  static efficiency versus dynamic efficiency  uncovering costs for intangibles-developing  mis-definition of the cost of capital