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IJOES
34,3 Intellectual capital reporting and
its relation to market and
financial performance
266 Mishari M. Alfraih
Accounting Department, College of Business Studies,
Received 26 February 2017 The Public Authority for Applied Education and Training, Kuwait
Revised 10 May 2017
Accepted 14 May 2017

Abstract
Purpose – This paper aims to examine the relationship between the level of intellectual capital information
voluntarily disclosed in the annual reports of companies listed on the Kuwait Stock Exchange (KSE) and their
market and financial performance.
Design/methodology/approach – The classical framework developed by Sveiby (1997) and modified
by Guthrie et al. (2006) forms the basis for the content analysis of annual reports published by KSE-listed
companies in 2013. An intellectual capital disclosure (ICD) index is developed from this material. Two
traditional indicators of corporate performance, namely, market-to-book ratio and return on assets are used to
assess market and financial performance. Regression models are constructed to examine the association
between the level of ICD and corporate performance.
Findings – Empirical findings indicate that better ICD has a positive, statistically significant impact on
corporate performance. More specifically, the findings suggest that intellectual capital reporting plays a
significant role in enhancing market and financial performance.
Research limitations/implications – This study only focuses on intellectual capital information
disclosed in annual reports; other means of corporate communication were not considered. Nevertheless, the
annual report has stood the test of time as the best source of corporate disclosure.
Practical implications – Given the importance of intellectual capital reporting in enhancing corporate
performance, a practical implication of this study is to make managers aware of its positive and significant
effect on market and financial performance, which may encourage companies to develop better disclosure
policies. An important implication of the findings is that the policymakers and regulators need to encourage
listed companies to disclose their intellectual capital information to exploit the associated benefits.
Originality/value – This paper extends the literature by examining the influence of ICD on corporate
performance in the context of frontier markets, where economic, social, political and cultural conditions have
particular characteristics.
Keywords Kuwait, Corporate performance, Intellectual capital disclosure, Annual reports,
Financial reporting, Frontier markets
Paper type Research paper

1. Introduction
Although tangible assets such as property, plant and equipment continue to be significant
elements in the production of goods and services, their relative importance has decreased as
the relevance of assets such as intellectual capital (IC) has increased (Luthy, 1998). This
becomes particularly apparent when considering the dramatic shift from the industrial
International Journal of Ethics and
economy, in which tangible resources dominate, to a new, knowledge-based economy in
Systems which intangible, intellectual assets, such as IC, are key determinants of competitive
Vol. 34 No. 3, 2018
pp. 266-281
© Emerald Publishing Limited
2514-9369
DOI 10.1108/IJOES-02-2017-0034 JEL classification – M41, M42
advantage, economic success and value creation (Lev et al., 2005; Ellis and Seng, 2015). The Intellectual
observation is supported by a report from the World Bank (2005), which reveals that IC capital
constitutes the largest share of wealth in virtually all countries, accounting for 77 per cent
worldwide. IC encompasses the knowledge, information, intellectual property and
reporting
experience that can be used to create wealth (García-Meca and Martínez, 2005; Branco et al.,
2010). Its intangible nature distinguishes it from the traditional resources that appear in
financial reporting (Branco et al., 2010; Mehralian et al., 2012).
The lack of a clear definition and measurement difficulties mean that IC assets are often 267
unreported in financial statements, although they may constitute up to 80 per cent of a
company’s market value (Cheng et al., 2010). Interestingly, even International Financial
Reporting Standards (IFRS) do not help in redefining many of the concepts, principles and
valuation methods of IC assets[1] (Zéghal and Maaloul, 2010). Although there is a lack of
consensus on its definition, the literature broadly defines it as the difference between a
company’s market value and its book value (Ordoñez de Pablos, 2003; Haji and Ghazali, 2013).
At the same time, research has noted the gap between a company’s market value and its book
value (Chu et al., 2011), which is a concern for investors (Hurwitz et al., 2002). Hulten and Hao
(2008) argue that the US’ equity market consistently values shareholder equity at more than
twice the value appearing on traditional corporate balance sheets (in other words, the book
value). Similarly, Inkinen (2015) shows that the average company’s IC is estimated to be three to
four times its book value. Numerous observers have pointed to the absence of IC assets in
traditional corporate reporting as an important explanation for this phenomenon (Lev, 2001;
Chen et al., 2005; Hulten and Hao, 2008).
IC has attracted much research attention in the past 15 years (Chen et al., 2005; Whiting and
Woodcock, 2011), encouraged by claims that IC information could result in more-informed
investment decisions (Graaf, 2013). In 2015, Ernst & Young (EY) commissioned a study
exploring institutional investors’ views on IC asset reporting by publicly traded companies
worldwide. The study revealed that today, more than ever, institutional investors use
companies’ IC disclosure to inform and underpin their decisions. This view is understandable,
as there are an increasing number of examples where companies’ intangibles outvalue their
tangible assets [Ernst & Young (EY), 2015]. Similarly, Bismuth and Tojo (2008) argue that
providing the market with sufficient and appropriate information about intellectual assets
improves investors’ decision-making and helps to discipline management and boards, with
positive economic consequences. However, despite clear interest from the investor base, many
companies have yet to respond [Ernst & Young (EY), 2015].
The theoretical literature has suggested that IC has a positive impact on corporate
performance (Inkinen, 2015). For example, Gu and Lev (2011) argue that IC is a major driver of
economic growth and corporate performance in most economic sectors. Clarke et al. (2011)
claim that a company’s value is often partly based on its IC assets; therefore, the efficiency of IC
utilization has a direct influence on performance. Lin et al. (2012) put forward similar
arguments. Cuozzo et al. (2017) emphasize that more empirical research is required as there is
little supporting evidence for the theory (Wang and Chang, 2005), especially as current results
are mixed. Some studies have documented that IC has a positive impact on corporate
performance (see for example, Chen et al., 2005; Tovstiga and Tulugurova, 2007; Ting and
Lean, 2009; Cheng et al., 2010; Clarke et al., 2011; Massaro et al., 2015; Andreeva and Garanina,
2016; Martini et al., 2016), while others are inconclusive (see for example, Huang and Liu, 2005;
Kamath, 2007; Ghosh and Mondal, 2009; Maditinos et al., 2011; Dženopoljac et al., 2016).
Furthermore, most of the literature has focused on mature market economies, and there
are few studies in emerging and frontier markets. Kamath (2007) argues that the
implications of IC are greater in these economies, as they have abundant intellectual and
IJOES human capital at their disposal. Sukumaran et al. (2015) argue that, in contrast to developed
34,3 market economies, frontier markets are smaller and less accessible and can be seen as a
subclass of emerging market economies. MSCI, a leading provider of global indexes,
currently lists 23 markets[2] in its frontier markets index, including Kuwait (MSCI, 2016).
This study therefore addresses these gaps in the IC literature and examines the claim that IC
is a driver for corporate performance in the frontier market of Kuwait. More specifically, it
268 empirically investigates the association between the extent of IC reporting by companies
listed on the Kuwait Stock Exchange (KSE) and two traditional measures of corporate
performance, namely, market performance and financial performance. The study draws its
theoretical foundations from the resource-based view to develop two hypotheses. The
findings help to assess the effectiveness of IC as a tool and identify opportunities for
potential improvements.
The remainder of this paper is organized as follows: Section 2 reviews the literature on
both IC reporting and corporate performance and develops the hypotheses. Section 3
outlines the method. Section 4 presents an analysis of the data and the results of the study.
Finally, Section 5 presents the summary and concluding comments.

2. Literature review and hypothesis development

2.1 Theoretical literature
Corporate disclosure has attracted significant attention in the wake of recent scandals (Jiao,
2011; Alfraih, 2016). Disclosure is, potentially, an important way for management to
communicate performance to outside investors (Healy and Palepu, 2001). A large body of
theoretical literature examines the motives for managers to disclose such information. The
unraveling results model developed by Grossman (1981) and Milgrom (1981) identifies six
conditions under which companies voluntarily disclose information. These conditions
include:
(1) disclosures are costless;
(2) outside parties know that companies have information;
(3) all outside parties interpret the companies’ disclosures in the same way, and
companies’ know-how outside parties will interpret that disclosure;
(4) managers want to maximize their companies’ share prices;
(5) companies can credibly disclose their information; and
(6) companies cannot commit ex-ante to a specific disclosure policy.

Other work has adopted agency theory (Jensen and Meckling, 1976) as the primary
framework (Albassam, 2014), which has been supplemented by signaling theory (Akerlof,
1970; Morris, 1987), stakeholder theory (Freeman, 1984), resource dependence theory (Pfeffer
and Salancik, 1978), proprietary cost and competition theory (Verrecchia, 1983) and capital
market theory (Choi, 1973).
Corporate annual reporting has proven to be the best source of disclosure (Cuozzo et al.,
2017). It is one of the primary ways in which companies communicate with stakeholders;
however, rapid changes in the broader business environment have increased concerns about
whether it continues to fulfill its objectives (Kriz and Blomme, 2016). The issue has become
particularly apparent in the new, knowledge-based economy where IC assets create value
and indicate a company’s future potential. Consequently, the value of a company can no
longer be accurately measured by the value of its physical assets, as demonstrated by
acquisitions (Arkblad and Milberg, 2006).
 Hurwitz et al. (2002) contend that the main argument for the influence of IC on company Intellectual
performance arises from the resource-based view. According to this view, IC consists of capital
information, intellectual property, intellectual material, knowledge, core techniques,
customer relationships and experience assets that are difficult to copy or substitute and
reporting
which can be used to create wealth (Inkinen, 2015). From this perspective, it can be viewed
as a powerful competitive weapon in business (Wang and Chang, 2005). IC is intangible and
can be thought of as a form of “unaccounted capital” in the traditional accounting system
(Abeysekera and Guthrie, 2005). 269
As highlighted above, there is no consensus on the definition of IC in the literature, but
three elements have emerged: human capital, structural capital and customer (relational)
capital (Wang and Chang, 2005). Riahi-Belkaoui (2003) highlights human capital as helpful
in innovating new products and services, in addition to enhancing business processes and
practices. Structural capital consists of the knowledge that belongs to the company as a
whole, in terms of inventions, strategies, technologies, data, culture, publications, systems,
structures, organizational routines and procedures. Customer capital comprises the
company’s value generated from its franchises, ongoing relationships with its customers,
customer retention and defection rates and per-customer profitability (Riahi-Belkaoui, 2003).
According to this definition, IC cannot be owned and controlled by the company – a useful
example is employees’ knowledge (Goh, 2005).
Cheng et al. (2010) argue that although IC assets may constitute 80 per cent of a
company’s market value, they often go unreported in financial statements. However, in
recent years, disclosure has gained in importance (Alfraih and Almutawa, 2017) and is
increasingly perceived as an integral part of company valuation (Bukh, 2003). Users of
annual reports have listed IC information as one of their top ten needs (Goh, 2005). In a
worldwide study, 80 per cent of investors considered nonfinancial information to be
essential or important when making decisions [Ernst & Young (EY), 2015]. The increasing
awareness of the importance of IC has motivated many companies to provide IC information
in their annual reports on a voluntary basis to enhance the transparency between
management and various stakeholders (Yi and Davey, 2010). Gamerschlag (2013) shows
that IC disclosure provides useful information for decision-making and is regarded as an
important driver of long-term corporate financial performance. Healy and Palepu (2001)
document that companies with higher levels of disclosure experience significant
contemporaneous increases in stock prices that are unrelated to current earnings
performance. Advocates of resource-based theory suggest that corporate performance is a
function of the effective and efficient use of the company’s tangible and intangible assets
(Firer and Williams, 2003). In their comprehensive review of IC studies for the period 2000-
2017, Cuozzo et al. (2017) note that IC theory has two principal foundations: namely, the
difference between market-to-book values and the disclosure of IC as a means to increase
profitability. Taken together, the theoretical literature suggests that IC reporting has a
positive impact on corporate performance (Inkinen, 2015).

2.2 Empirical literature

Inkinen (2015) reviews the empirical research on the relation between IC and corporate
performance and notes that the topic has received increasingly attention since the early
2000s. A variety of measurement models have been deployed. Although on a theoretical
level, IC is a driver of performance, Maditinos et al. (2011) argue that the empirical evidence
is inconclusive. Nevertheless, Inkinen (2015) finds that several empirical studies support the
notion that IC enhances corporate performance. For example, Chu et al. (2011) find a positive
relationship among companies listed on the Hong Kong Stock Exchange for the years 2001
IJOES to 2009. The study also supports the notion that the role of physical capital is diminishing
34,3 over time, as companies replace it with IC capital. Similarly, in Taiwan, Chen et al. (2005)
find that investors value companies with better IC resources more highly and that such
companies have better profitability and revenue growth. In India, Kamath (2008) find that IC
has a major impact on the profitability and productivity of pharmaceutical companies
between 1996 and 2006. Vishnu and Gupta (2014) confirm these results. Using data from
270 listed companies in the UK, Zéghal and Maaloul (2010) find a positive relationship for
economic and financial performance. However, the association between IC and stock market
performance is limited to high-tech industries. In the transitional economy context, Tovstiga
and Tulugurova (2007) find that IC is perceived by Russian managers to be a primary
determinant of corporate performance. Andreeva and Garanina (2016) confirm these results
and demonstrate that structural and human capital positively influence Russian
manufacturing companies’ corporate performance, explaining a quarter of its variation.
From a resource-based perspective, Cheng et al. (2010) find a positive relationship in the
USA healthcare industry. Similarly, Joshi et al. (2013) confirm that value creation in the
Australian financial sector is highly influenced by IC. In the context of Luxembourg and
Belgium, Mention and Bontis (2013) confirm that human capital contributes both directly
and indirectly to performance in the banking sector. Finally, Nimtrakoon’s (2015) study of
listed companies in Indonesia, Malaysia, Philippines, Singapore and Thailand finds a
significant effect on market value and financial performance measures.
However, other results are mixed or negative. For example, using data from listed
companies in South Africa, Firer and Williams (2003) explore the association between
physical capital and IC and three traditional dimensions of corporate performance, namely,
profitability (returns on assets), productivity (turnover of total assets) and market value
(market-to-book value ratio of net assets). Surprisingly, they find a negative association.
Similarly, in Argentina, F-Jardon and Martos (2009) reveal that only structural capital
affects performance, while no effect was observed for human or relational capital. Mixed
results are documented by Ghosh and Mondal (2009) in India. Their empirical evidence finds
that IC can explain profitability (return on assets) but not productivity (assets turnover
ratio) and market valuation (market-to-book ratio). Maditinos et al. (2011), in Greece, and
Dženopoljac et al. (2016), in Serbia, fail to find support for the hypothesis that there is a
relationship between IC and market value or financial performance.

2.3 Hypotheses
In an era of knowledge-based resources, IC is a key determinant of competitive advantage,
economic success and value creation (Lev et al., 2005). The resource-based view argues that
companies can improve financial performance through the acquisition, holding and
subsequent use of intellectual assets (Ghosh and Mondal, 2009). IC represents value that is
difficult to copy or substitute (Hurwitz et al., 2002), while differences in performance can be
explained by differences in resource portfolios and how they are used (Mention and Bontis,
2013). As IC is clearly a critical resource that is expected to contribute to better performance
(Zéghal and Maaloul, 2010), more IC information disclosed in a company’s annual report
should represent a source of competitive advantage and thus lead to better corporate
performance. Despite the lack of consensus in previous work, this study predicts a positive
impact for KSE-listed companies. Specifically, the study predicts that higher IC disclosure in
a company’s annual report is consistent with better market and financial performance.
Therefore, the following hypotheses are developed:
 H1. The level of voluntary, corporate intellectual capital disclosure is positively Intellectual
associated with market performance, measured by the market-to-book ratio. capital
H2. The level of voluntary, corporate intellectual capital disclosure is positively reporting
associated with financial performance, measured by return on assets.

3. Data and research methods 271

3.1 Sample and data collection
This study examines the relationship between the level of voluntary IC disclosure and
corporate performance for companies listed on the KSE. The 2013 Investor Guide for the
KSE shows that at the end of 2013, there were 195 such companies. Thirteen companies
were removed due to missing data, leaving a final sample of 182 companies, representing 93
per cent of all KSE listed at the end of 2013. This was divided into the following industrial
sectors: financial institutions (17 companies), investment (40), manufacturing (33), services
(56) and real estate (36). The analysis focuses on annual reports for the 2013 fiscal year.
Although IC disclosure can take various forms, the annual report has stood the test of time
(Cuozzo et al., 2017). Campbell (2000) argues that this is because:

The company has complete editorial control over the content (except audited
financials).

It is public, free and widely distributed.

Reports were either downloaded from the official company website or the company was
contacted directly. Corporate performance measures and control variables were drawn
either from annual reports or the official KSE website (www.boursakuwait.com.kw).

3.2 Measurement of corporate performance – dependent variables

Although there is no specific theoretical framework or empirical evidence that supports the
superiority of any specific corporate performance measure over others (Firer and Williams,
2003), the literature typically uses two indicators:
(1) market-to-book ratio (MB); and
(2) return on assets (ROA).

MB is computed as the ratio of total market capitalization (share price multiplied by the
number of outstanding common shares) to book value of net assets. ROA is the ratio of net
income to total assets. Consistent with Firer and Williams (2003); Chen et al. (2005); Huang
and Liu (2005); Kamath (2008); Ghosh and Mondal (2009); Zéghal and Maaloul (2010); Chu
et al. (2011); Clarke et al. (2011); Maditinos et al. (2011); Joshi et al. (2013); Vishnu and Gupta
(2014); Nimtrakoon (2015); Dženopoljac et al. (2016), these two indicators are adopted here.

3.3 Measurement of intellectual capital disclosure – independent variable

Although the practice of measuring IC as intangible asset has been debated (Riahi-Belkaoui,
2003), the literature documents several methods. Branco et al. (2010) observe that most
studies use content analysis. Martini et al. (2016) argue that this approach is particularly
useful in textual analysis and can be considered as a valid instrument for analyzing non-
financial information. It is based on the principle of classifying qualitative and quantitative
information into lexical or semantic groups and assessing specific lexical items in terms of
quantity and quality (Guthrie et al., 2004; Martini et al., 2016).
IJOES One of the most-widely used IC classification schemes is the threefold framework
34,3 developed by Sveiby (1997). The original framework classifies IC into three areas:
internal structure, external structure and employee competence. Although the initial
framework has been modified and extended, it has not yet been substantially replaced
(Dumay and Cai, 2015). This study uses the original framework, as modified by Guthrie
and Petty (2000), Guthrie et al. (2004) and Guthrie et al. (2006), which consists of 24
272 attributes divided into three main categories. Internal capital captures the systems,
policies, culture and other organizational capabilities designed to meet market
requirements. External capital refers to connections with people outside the
organization. Human capital includes the know-how, capabilities, skills and expertise
of employees (Guthrie et al., 2004). All 24 elements are presented in Table I. To ensure
their applicability and relevance to the Kuwaiti business environment and company
practice, these attributes were reviewed and validated by an academic and scrutinized
by two experienced professionals specialized in financial reporting and disclosure in
Kuwait.
The vast majority of disclosure studies adopt a dichotomous, item-based approach in
which an element scores one if it is disclosed and zero otherwise (Chavent et al., 2006).
Consistent with this approach and following Guthrie and Petty (2000), April et al. (2003),
Goh and Lim (2004), Li et al. (2008), Abeysekera (2010) and Haji and Ghazali (2013), in this
study each of the 24 attributes was coded. Scoring was based on a careful review of each
annual report. Once the actual score was obtained, the ratio of actual disclosure to the
maximum possible score of 24 was calculated as the Intellectual Capital Disclosure (ICD)
index.

3.4 Control variables

The choice of control variables followed previous work and comprised: company size (Firer
and Williams, 2003; Huang and Liu, 2005; Kamath, 2008; Ghosh and Mondal, 2009; Zéghal
and Maaloul, 2010; Chu et al., 2011; Joshi et al., 2013; Riahi-Belkaoui, 2003; Nimtrakoon, 2015;
Dženopoljac et al., 2016), leverage (Firer and Williams, 2003; Huang and Liu, 2005; Kamath,
2008; Ghosh and Mondal, 2009; Zéghal and Maaloul, 2010; Chu et al., 2011; Clarke et al., 2011;
Riahi-Belkaoui, 2003; Dženopoljac et al., 2016) and industrial sector (Firer and Williams,
2003; Huang and Liu, 2005; Clarke et al., 2011; Joshi et al., 2013).

Internal capital External capital Human capital

Intellectual Property Brands Education

Corporate culture Customers Know-how
Patents/Copyrights/Trade marks Company names Work-related knowledge/
competencies
Information systems Customer satisfaction Academic qualification
Networking systems Customers loyalty Professional qualification
Management process Distribution channels Human capital/resources
Management philosophy Business collaboration Training
Financial relations Licensing agreements Entrepreneurial spirit,
Table I. innovativeness, proactive and
Elements of reactive abilities, changeability
intellectual capital
disclosure Sources: Adopted from Guthrie and Petty (2000) and Guthrie et al. (2004, 2006)
3.5 Empirical models Intellectual
Two regression models tested the relation. Model (1) tested the relation between market capital
performance, ICD and control variables. It is expressed as follows:
reporting
MB ¼ b 0 þ b 1 ICD þ b 2 SIZE þ b 3 LEV þ b 4 IND_FIN þ b 5 IND_INV
(1)
þ b 6 IND_MUNF þ b 7 IND_SERV þ «

Model 2 tested the relation between financial performance, ICD and control variables. It is 273
expressed as follows:

ROA ¼ b 0 þ b 1 ICD þ b 2 SIZE þ b 3 LEV þ b 4 IND_FIN þ b 5 IND_INV

(2)
þ b 6 IND_MUNF þ b 7 IND_SERV þ «

where:
MB = Market-to-book ratio. The ratio of the total market capitalization (share
price times number of outstanding common shares) to book value of net
assets;
ROA = The ratio of net income to total assets;
ICD = The intellectual capital disclosure index score;
SIZE = Total assets at the end of 2013;
LEV = The ratio of total debt to total shareholder equity at the end of 2013;
IND_FIN = Dummy variable that equals 1 for companies in the financial institutions
category and 0 otherwise;
IND_INV = Dummy variable that equals 1 for companies in the investment category
and 0 otherwise;
IND_MUNF = Dummy variable that equals 1 for companies in the manufacturing
category and 0 otherwise; and
IND_SERV = Dummy variable that equals 1 for companies in the services category
and 0 otherwise, (if all of these categories are zero then the firm is in the
real estate category).

4. Empirical results
4.1 Descriptive statistics
Panel A of Table II presents descriptive statistics for dependent, independent and
continuous control variables. Mean MB is 1.10, ranging from 0.32–3.89. Mean ROA is
0.03, ranging from 0.25-0.23. ICD ranges from 0-96 per cent, with a mean of 28 per cent
and standard deviation of 22 per cent. Company size (total assets) varied significantly,
ranging from Kuwaiti Dinar (KD) 1.68 m to KD 18,600.14 m, with a mean of KD 207.45
m. As the distribution was non-normal, this variable was log-transformed. Mean
leverage was 37 per cent, ranging from 0.02-0.89 per cent. Panel B shows the analysis of
industrial sector.

4.2 Correlation analysis

Pearson’s correlation coefficients for dependent, independent and continuous control
variables are presented in Table III. ICD has positive and significant (p < 0.01) correlations
with both MB and ROA. Overall, these results imply that KSE companies with higher levels
of ICD are associated with better corporate performance, thus providing initial support for
the study’s hypotheses. No high pair-wise coefficients are found for independent variables.
IJOES Variable Mean SD Minimum Maximum
34,3
Panel A
Market-to-book ratio (MB) 1.10 0.65 0.32 3.89
Return on assets (ROA) 0.03 0.06 0.25 0.23
Intellectual capital disclosure (ICD) 0.28 0.22 0.00 0.96
Company size (Size) 533.25 207.45 1.68 18,600.14
274 Company size (transformed) 18.28 1.58 14.34 23.65
Leverage (LEV) 0.37 0.24 0.02 0.89
Panel B
Variable Frequency (%)
Financial institution category (IND_FIN) 17 9
Table II. Investment category (IND_INV) 40 22
Manufacturing category (IND_MUNF) 33 18
Descriptive statistics Services category (IND_SERV) 56 31
for dependent and Real estate category (IND_REAL) 36 20
independent
variables Note: N = 182

Variable MB ROA ICR SIZE LEV

Table III. Market-to-book ratio (MB) 1.00

Bivariate correlations Return on assets (ROA) 0.07 1.00
Intellectual capital disclosure (ICD) 0.34*** 0.12*** 1.00
between continuous Firm size (Size) 0.15** 0.01*** 0.30*** 1.00
dependent and Leverage (LEV) –0.05 –0.08 0.11*** 0.11*** 1.00
independent
variables Note: **, *** Pearson correlation is significant at # 0.05 and 0.01 levels, respectively (two-tailed)

4.3 Regression results

Consistent with prior studies, multiple regression analysis was used to test the study’s
hypotheses (Table IV). Multicollinearity was tested for examining tolerance and variance
inflation factors (VIF). Columns 2 and 3 of Table IV show that both tolerance and VIF for all
independent variables are above 0.1 and below 10 respectively, suggesting that
multicollinearity is unlikely (Pallant, 2013).
4.3.1 Market performance (model 1). Column 2 of Table IV presents the results of
regressing MB on ICD and control variables. The model was statistically significant (F =
7.90, p < 0.01). The adjusted R2 shows that ICD and control variables jointly explained 34
per cent of variation. After controlling for company size, leverage and industrial category, ICD
is positive and significant (p < 0.05). This finding provides empirical support for Hypothesis
(H1), which predicts that higher disclosure is consistent with better market performance and
confirms earlier work (Chen et al., 2005; Nimtrakoon, 2015). Model 1 shows that control
variables size and leverage do not contribute significantly to variation. Mixed results were
observed for industrial category. Financial Institution (p < 0.01) and Services (p < 0.05) were
significant. In contrast, no significant differences were observed for Investment and
Manufacturing.
4.3.2 Financial performance (model 2). Hypothesis (H2) predicts that financial
performance is consistent with better disclosure. Column 3 of Table IV shows the results of
 Dependent Variables: MB and ROA
Intellectual
Column 1 Column 2 Column 3 capital
Model 1 Model 2 reporting
Market performance (MB) Financial performance (ROA)
Collinearity statistics Collinearity statistics
Variable B t-stat. Sig. Tolerance VIF B t-stat. Sig. Tolerance VIF

Intercept 1.33 1.39 0.20 4.50 0.59 0.57

275
ICD 0.67 2.73 0.02** 0.77 1.30 3.64 2.45 0.04** 0.80 1.24
SIZE 0.03 0.75 0.47 0.63 1.59 0.81 2.31 0.05* 0.77 1.31
LEV –0.03 –0.31 0.76 0.93 1.07 –0.61 –0.88 0.40 0.95 1.05
IND_FIN 1.06 3.77 0.00*** 0.47 2.11 3.94 2.60 0.04** 0.51 1.96
IND_INV –0.09 –0.48 0.64 0.57 1.77 2.41 1.62 0.14 0.55 1.83
IND_MUNF 0.25 1.17 0.28 0.66 1.53 2.33 1.34 0.22 0.64 1.57
IND_SERV 0.48 2.49 0.04** 0.58 1.73 2.98 1.95 0.09* 0.62 1.62
Adj. R2 0.34 0.18
F-stat 7.90*** 4.73***
N 182 182

Notes: *, **, *** Significant at # 0.10, 0.05 and 0.01 levels respectively (two-tailed). MB is the ratio of the
total market capitalization (share price times number of outstanding common shares) to book value of net
assets for company i at time t; ROA is the ratio of the net income to the total assets for company i at time t; Table IV.
ICD is the intellectual capital disclosure index score; SIZE is the natural logarithm of the total assets of Regression of market
company i at time t; LEV is the ratio of total debt to total assets of company i at time t; IND_FIN is dummy
and financial
variable that equals one for companies in the financial institutions category and zero otherwise; IND_INV is
dummy variable that equals one for companies in the investment category and zero otherwise; IND_MUNF performance
is a dummy variable that equals one for companies in the industrial category and zero otherwise; measures on
IND_SERV is a dummy variable that equals one for companies in the services category and zero otherwise intellectual capital
(the omitted industry category when all categories are zero is the real estate category); t = 2013 fiscal year disclosure

regressing ROA on ICD, after controlling for company size, leverage and industrial category.
This model was also significant (F = 4.73, p < 0.01) and explained about 18 per cent of
variation. This results is also consistent with earlier work (Chen et al., 2005; Zéghal and
Maaloul, 2010; Chu et al., 2011). Company size, leverage, investment and manufacturing are
not significantly associated with financial performance. In contrast, Financial institution
(p < 0.05) and services (p < 0.10) categories are significant.
Overall, the analyses support the hypothesis that ICD has a positive and significant
impact on corporate performance. In particular, the empirical results support the Hypothesis
(H1) that market performance, as measured by MB, is significantly influenced by ICD.
Similar support was found for Hypothesis (H2), namely, that financial performance, as
measured by ROA is significantly influenced by ICD. These results extend our
understanding of the role of IC information in frontier markets, with particular economic,
social, political and cultural characteristics.

5. Conclusion
This paper examines how voluntarily IC disclosure, as found in the annual reports of
companies listed on the KSE influences corporate performance. Drawing on the resource-
based view, it develops two hypotheses regarding the influence of IC information. The aim is
to assess its effectiveness as a tool and identify potential areas for improvement. Despite a
lack of consensus in previous studies, the study predicted a positive impact on KSE-listed
IJOES companies. Specifically, the study predicted that better disclosure in the company’s annual
34,3 report is consistent with better market and financial performance.
An ICD index, inspired by the classical framework developed by Sveiby (1997) and
modified by Guthrie et al. (2006), provided the basis for a content analysis of the annual
reports published by KSE-listed companies in 2013. Consistent with prior studies, disclosure
is divided into three main categories:
276 (1) internal capital;
(2) external capital; and
(3) human capital.

Each category has eight attributes. A forward-looking market-based measure (market-to-

book ratio) and a historical, financial-based measure (return on assets) measured
performance. Regression models examined the association between IC reporting and
performance. Overall, the findings suggest a positive relationship between ICD
and performance. These results provide empirical support for the theoretical prediction of
the influence of IC information on corporate market and financial performance.
This study contributes to the literature by presenting empirical evidence on the influence
of IC information on corporate performance, using data from KSE-listed companies. The
results extend knowledge on the role of IC reporting in capital markets, by broadening its
scope to include frontier markets. A practical implication is to make managers aware of the
positive and significant effect of IC information on performance, which may encourage
companies to develop better disclosure policies. An important implication is that the
policymakers and regulators need to encourage listed companies to disclose IC information
to exploit the associated benefits.
Although this study supports and complements the current literature and contributes to
the theoretical and empirical debate on the impact of disclosure, there are some
methodological limitations. First, it only examines annual reports. Future research could
investigate the disclosure of IC information in other corporate communications, such as the
company’s website, press releases, conferences and prospectuses. Second, it suffers from
the subjectivity that is inherent in the use of content analysis to score the level of disclosure,
which is a concern in this and prior studies. Several precautions were taken to increase
objectivity. Future research could investigate IC using the value added intellectual
coefficient method as an IC indicator. Third, time limitations meant that the sample
was limited to a one-year period. Future research could investigate changes in the
relationship between corporate performance and disclosure. Despite these limitations, this
study makes a significant contribution to the IC debate by examining its relation to
corporate performance in frontier markets.

Notes
1. Although the International Accounting Standards Board (IASB) regulates IC assets under
IAS 38 (Intangible Assets), IAS 36 (Impairment of Assets) and IFRS 3 (Business
Combinations), as clear as these standards may seem, they can be problematic to implement
(Arkblad and Milberg, 2006).
2. The 23 frontier market countries are: Argentina, Bahrain, Bangladesh, Bulgaria, Croatia,
Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Morocco,
Nigeria, Oman, Pakistan, Romania, Serbia, Slovenia, Sri Lanka, Tunisia and Vietnam (MSCI,
2016).
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Further reading
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About the author

Mishari M. Alfraih, PhD, CPA, CIA, is an Associate Professor of Accounting at the College of
Business Studies, The Public Authority for Applied Education and Training, Kuwait. He holds a PhD
in Accounting from Queensland University of Technology, Australia. He is a Certified Public
Accountant (CPA), Certified Internal Auditor (CIA) and a Certified Fraud Examiner (CFE). Dr
Alfraih’s research interest focuses on the role of information in capital markets and IFRS reporting
practices. His research areas in IFRS include financial information flows, information quality,
decision usefulness of financial reporting and audit quality in emerging capital markets. Mishari M.
Alfraih can be contacted at: [email protected]

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