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D6:   The Economics of Knowledge Capital: Analysis of European Firms
    By Paul A. Strassmann
    115 Pages
    Date Published: 12/2001

    Online Price: $14.95

Summary

The valuation of knowledge capital makes it possible to assess the worth of the people who possess the accumulated knowledge about an organization. They are the individuals who leave the workplace every night (and may never return), storing in their heads the know-how acquired while receiving full pay. Their brains are repositories of knowledge accumulated over untold hours of listening and talking while not delivering any goods or services to paying customers. The employees' minds, and the files they manage, carry a share of the company's knowledge capital. This makes every employee a custodian of the most important assets a firm owns, even though these assets never show up on any financial reports. The disciplines and methods how to account and safeguard knowledge assets are either non-existent or at most rudimentary.

By contrast, the custodianship of financial assets has become a well-defined discipline that depends on procedures and regulations on how to account for and report these resources. Over a period of many years, an elaborate framework involving accountants, auditors, reporting standards and government oversight has been developed to do that.

What has changed now is the discovery that the financial assets of corporations represent only a portion of the total corporate assets. In many cases the valuation of the financial assets is dwarfed by the implied valuation of its knowledge assets. As society evolves from an industrial model how an economy functions to an information based economy, knowledge assets become increasingly important.

Financial executives have shown a remarkable reluctance to put numbers on something many consider to be intangible. However, with the rising importance of non-financial assets the time has come to place the management of knowledge on the agenda of executive managers, financial analysts and shareholders. To that end, one must start by developing an independently verifiable quantification of the worth of knowledge assets.

Knowledge capital can be calculated because it reveals itself as the most important contributory influence in explaining how a firm earns its profits in excess of its cost of financial capital. The allocation of the respective contributions of knowledge capital and financial capital to profits can be made if one recognizes that financial capital is now a commodity - readily available at a price that reflects the interest rate that a firm pays for its borrowings, the price a shareholder can earn for an investment made at a lower risk. However, what makes a company prosper is not financial capital - which anyone can obtain for a price - but the effectiveness with which knowledge capital is put to use. Therefore, the annual returns realized on knowledge capital can be isolated after paying a "rental" for the financial capital and then subtracting that amount from profits as reported by the accountants.

What remains is what economists call an "economic profit" and what some consultants call the "economic value-added." I label that residual as the "knowledge value-added" because it accounts for those missing elements that represent everything not shown on a conventional balance sheet. By filtering out the contributions of financial capital from the reported profits, we are left with a residual that is entirely attributable to what knowledge capital has actually delivered. In other words, knowledge value-added is the annual yield a firm realizes from its knowledge capital assets.

Once you know the yield from a capital asset, calculating the value of its principal is straightforward. All you have to do is to divide the value of knowledge value-added by the costs of that capital and you get a verifiable and independently reproducible worth of a firm's knowledge capital.

To provide an overview of Knowledge Capital® in Europe is a vast undertaking. Such a study would have to cover issues related to economic growth, corporate structure, the costs of capital and the rates at which various firms have demonstrated a consistent capability of accumulating Knowledge Capital in preference to financial assets.

This report should be seen as a first installment in a more comprehensive effort to map the characteristics of Knowledge Capital formation in Europe. This study comes in two parts.

Part I examines the overall characteristics of the distribution of Knowledge Capital without dwelling in greater detail into the relationships and trends that lead to its influence of corporate profitability and long term viability. The financial statistics are expressed in terms of Euros currency to reflect the plans to apply similar analyses to other European countries for comparability. All information cited herein is available form public sources and reflects results of audited financial reports for public corporations, as tabulated by the Standard & Poor's Global financial services databases.

Part II examines some of the patterns of Knowledge Capital of the U.K. economy. The corporate population covered includes detailed data about 1,152 U.K firms with a total workforce of 7.1 million which represents a large share of what I term as the engines of knowledge capital creation. Similar analyses will be prepared for other European countries in due course.

CONTENTS

Contents 4
Figures 7
Introduction 8
Summary Findings 11
Part I: Knowledge Capital in European Firms 13
Effect of the Cost of Capital 14
Comparisons of Knowledge Capital Gainers vs. Losers 15
Concentration of Knowledge Capital 17
Industrial Sector Profiles 18
Sectoral Concentration Ratios 21
Part II - Country Case - The U.K. Knowledge Capital 23
Concentration of Knowledge Capital 23
Sectoral Distribution of Knowledge Capital 25
Knowledge Capital per Employee 26
Market Valuation of Knowledge Capital 29
Example of U.K. Knowledge/Financial Capital Ratios 31
Summary Findings, U.K. Case 32
Appendix A - Knowledge Capital Rankings 34
Knowledge Capital Rankings of Belgian Firms 34
Knowledge Capital Rankings of Danish Firms 37
Knowledge Capital Rankings of Finnish Firms 40
Knowledge Capital Rankings of French Firms 43
Knowledge Capital Rankings of German Firms 55
Knowledge Capital Rankings of Irish Firms 66
Knowledge Capital Rankings of Italian Firms 68
Knowledge Capital Rankings of Netherlands Firms 72
Knowledge Capital Rankings of Norwegian Firms 76
Knowledge Capital Rankings of Portuguese Firms 79
Knowledge Capital Rankings of Spanish Firms 80
Knowledge Capital Rankings of Swedish Firms 83
Knowledge Capital Rankings of U.K. Firms 88
Appendix B - Valuation of Knowledge Capital 111

FIGURES

Figure 1 - Summary of the Scope of the Report on European Knowledge Capital 13
Figure 2 - Risk-free Cost of Capital for European Countries 15
Figure 3 - Profiles of Positive and Negative Contributions to Knowledge Capital 16
Figure 5 - Knowledge Capital can be Found to be Highly Concentrated 17
Figure 6 - Sectoral Profile of European Firms 19
Figure 7 - Sectoral Ratios of Positive and Negative Knowledge Capital Firms 20
Figure 8 - Sectoral Concentration of Knowledge Capital 21
Figure 9 - Sectoral Concentration of Knowledge Capital vs. Firm Size 22
Figure 10 - Distribution of Knowledge Capital Among U.K. Firms 23
Figure 11 - The Top-Ranking U.K. Knowledge Capital Firms 24
Figure 12 - Knowledge/Finance Capital Ratios for Sectors of the U.K. Economy 25
Figure 13 - Knowledge/Finance Capital Ratios for U.K. Basic Materials Firms 26
Figure 14 - Knowledge Capital per Employee for U.K. Industrial Sectors 27
Figure 15 - Distribution of Knowledge Capital per Employee for Utility Sector 28
Figure 16 - Knowledge Capital per Employee for the Top Ranked Utility Sector 28
Figure 17 - Relationship Between Actual and Calculated Market Valuations 29
Figure 18 - Actual and Calculated Market Valuations for Financial Sector 30


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