Annual reports distort the value of innovation


Companies' annual reports are not capturing the full value of their innovative activities and could even be distorting their true market value, according to researchers at London's Cass Business School.

A team of academics analysed three unseen factors involved in innovation and their relation to business performance in almost 700 manufacturing and services companies.

These 'intangibles' were human capital (people and teams), structural capital (the processes, information systems and patents that remain when employees leave), and relational capital (links with customers, suppliers and other stakeholders).

What the research found is that conventional measures failed to reflect the drivers and effects of innovation in services.

For the most innovative companies, particularly those in the services sector, this could mean that analysts do not have enough information to work out a company's true market value.

A separate analysis of 2003 annual reports for 150 companies revealed that their coverage of intangibles was skewed towards their relational capital and away from human capital (60 per cent of commentary focusing on this) with just 14 per cent of mentions relating to human capital.

While this suggests that companies want to assure the market of their prospects by focusing on relations with customers and suppliers, the report warns that it also risks drawing attention away from longer-term drivers of innovation involving people working in teams.

"While intangibles have grown in importance, conventional accounting technology, however, remains ill-equipped to account properly for them," said Professor Chris Hendry, who led the research.

"These findings suggest there is an economic rationale for firms' current voluntary intellectual capital disclosures."

But he added that the weak focus uncovered on aspects of human capital implies that much of what firms write about people in their annual reports has little bearing on future business performance.

"This is not to say people don't matter, but that firms either add much that is irrelevant to performance or that they do not emphasise what does matter," he said.