Contingency Factors Influencing the Availability of
Internal Intellectual Capital Information
Ching Choo Huang
Accounting Research Institute & Faculty of Accountancy
Universiti Teknologi MARA
Email:
Michael Tayles
HullUniversity
Email:
Robert Luther
University of the West of England
Email:
Abstract
Purpose- This paper explores several contingency variables, namely environmental uncertainty, business strategy, technological advancement, market to book ratio, size, profitability and industry type in the context of management accounting and the availability of internal intellectual capital (IC) information.
Designmethodology/approach - A questionnaire was developed and posted to the managers of Malaysian companies. A multiple regression statistical technique was employed to analyse the data.
Findings - It was found that business strategy and technological advancement of customer service relate positively to the availability of internalIC information in Malaysian companies.
Research limitations/implications - The relatively small response of usable replies to the questionnaire survey is a limitation of this study. The finding implies that companies with more internal IC information are more likely to be those of product differentiators and those who have undergone technological advancement of customer service. Malaysian companies tend to have a strong customer orientation and place great emphasis on managing customer capital. Future research can investigate the types of IC information used by Malaysian managers to manage their customer capital.
Originality/value - This study contributes to the literature as it examines the relationship between context and IC within a contingency theory framework. Unlike other research which relates to external IC disclosures with firm-specific variables, this research links contingency factors to internal IC information from related fields (management accounting and external IC reporting).
Keywords Intellectual capital, Internal ICInformation, Contingency Factors, Malaysia
Paper type Research paper
Introduction
In the knowledge-based economy, the value of companies lies not only in physical assets, but in the human competencies, databases, organisational capabilities or intangibles that they possess; these characteristics are often referred to as intellectual capital (IC). When firms rely heavily on knowledge assets and other soft assets for success, the traditional financial reporting and management accounting systems are especially deficient. Indeed, with the growth in the knowledge economy, it is increasingly the case that, rather than technology or tangible assets alone, the intangible assets of a firm and its IC are the keys to achieving sustainable competitive advantage (Ortiz, 2006).
According to Vergauwen et al. (2007), conventional financial accounting and management accounting tools are not adequateto capture IC fully and report on these capabilities. However, the increasing importance of IC on the sustainability and long-term value of companies suggests that managers may have begun to be more explicit in managing and reporting their IC. In the context of external financial reporting, the demand for more information on IC or intangibles is inevitable (Simister et al., 1998). Regarding internal reporting, companies need more comprehensive information to better monitor and manage their IC. Managers need to produce IC information for effective governance and management of IC in business decisions. There is a considerable literature which addresses the provision of information, through the corporate report to external stakeholders, but less studies which capture and explain the content of internal management reports. This is despite the Malaysian survey findings of Tayles et al. (2007) which pointed out a greater presence of IC information in internal reporting than in external reporting. Though there remains a challenge to develop a robustand consistent external reporting framework for ICwhich can be framed in regulations, the supply or availability of internal IC information is at the discretion of management and may be determined by a set of external and firm-specific factors.
The objective of thispaper is to determine which characteristics are helpful in explaining the variation between companies regarding the availability of internal IC information. As studies regarding factors affecting internal IC availability are scarce, this study contributes to the literature as it studies the relationship between firm context and IC within a contingency theory framework. Unlike much of the previousresearchwhich relates IC external disclosure withfirm-specific characteristics or financial performance (Foong et al., 2009; Bontis et al., 2000), this research relates contingency factors to the availability of internal IC information in companies. It uses a comprehensive and robust instrument to detect the extent of internal IC information available and relates this to variables that have been used in earlier studies to explain the extent of general management accounting information. To the authors’ knowledge, no previous research of exactly this nature has been carried out in Malaysia. This study applies explanatory variables from related fields (management accounting and external IC reporting) to internal IC information. The empirical findings of some statistically significant explanatory variablesare helpful in explaining the existence of internal IC information in Malaysian companies.
The paper is structured as follows. The next section reviews literature related to IC components, determinants of IC and contingency theory. This is followed by a discussion on the research method which includes samples and respondents, questionnaire, usable questionnaires and response rate, non-response bias and reliability test,the development of an a priori model and hypotheses followed bythe multiple regression model employed. The fourth section deals with the results and discusses the research findings. The final section draws some conclusions from the findings, points to limitations and scope for future research.
Literature Review
Components of IC
A consensus on the definition and components of IC is yet to be reached in the literature. The Organisation for Economic Co-operation and Development (1999) describes IC as the economic value of two categories of intangible assets of a company: organisational (structural) capital and human capital. Most IC models however assume three components, namely customer capital, structural capital and human capital(Stewart, 1997; Sveiby, 1997; Roos et al., 1997). Human capital of a company rests in its people and hence is transferable. Structural capital is latent and concerned with systems and procedures which a company has to ensure its smooth running. Customer capital concerns with a company’s presence in the market.
Determinants of IC
Studies related to IC determinants drawn from external reporting, have been explored by different researchers. Wang and Chang (2005) studied association between the elements of IC and firm’s financial performance in the Taiwanese information technology industry. Claycomb et al. (2001) focused on the association between applied process knowledge and firm market performance in the context of environmental uncertainty. Bontis et al.(2000) investigated relationships between human, structural and customer capital and their influence on the business performance of Malaysian companies. Foong et al. (2009) studied the relationship between external IC disclosure and corporate characteristics of public listed companies in Malaysia. Studies above found that IC was positively associated withfirm’s market value and financial performance. There is however, as pointed out before, a paucity of information on internal IC provision and the factors which explain the availability of IC information. This paper seeks to fill this gap and explores the factors that influence the availability of internal IC information in Malaysian companies.
Contingency Theory
Contingency theory assumes that organisations attain effectiveness by fitting the characteristics of the organisation to contingencies that reflect the situation of the organisation (Donaldson, 2001). Generally, the contingency theory of management accounting postulates that there is no single management accounting system acceptable to all organisations. Contingency theory of management accounting aims to explain how particular circumstances (or contingencies) shape the form of an organisation's management control system (Otley, 1980a). The most appropriate management control system is contingent upon the circumstances faced by the organisation in which the implementation has to take place. As argued by Loft (1991), the development of accounting can also be seen not simply as a response to new needs but rather as being constitutive of them. Accounting, as an information system, plays an integral role in the developmentof organisations as the uncertainties they face become greater.
Elements of IC can be understood as characteristics of organisations which are affected by contingencies arising from the operational environment,it is assumed that the availability of internal IC information adapts to fit contextual factors or contingencies. Though some empirical results (see Wang and Chang, 2005; Claycomb et al., 2001) evidenced that IC in general has a positive influence on firm’s value and financial performance, such studies have focused on external information and value. Few studies systematically conceptualise and explain the relationship between operational environment (context) and internal IC information,but no such study has been done in Malaysia.
Research Method
Samples and Respondents
The data regarding the availability of IC information (46 line-items) and the contingency factors were collected via a postal survey to 520 companies listed on the main board of BursaMalaysia as in October 2005. These companies were from infrastructure, technology, consumer products, trading and services, construction, industrial products and properties sectors.
One hundred and four questionnaires were received from various sectors. Table 1 shows the number and percentage of respondents from each sector. Most respondents were from the trading and services and industrial products sectors, as they are the largest sectors in terms of number. Fifty three respondents specialised in finance and accounting; while 10 specialised in human resource.
Table 1: Respondents and Sectors
Sectors / Population / Respondents / Sector (%)Trading & services / 129 / 31(29.8%) / 24
Industrial products / 152 / 30 (28.8%) / 20
Properties / 99 / 16 (15.4%) / 16
Consumer products / 73 / 13 (12.5%) / 18
Construction / 43 / 11(10.6%) / 26
Technology / 16 / 2(1.9%) / 13
Infrastructure / 8 / 1 (1%) / 13
Total / 520 / 104 (100%) / 100%
Questionnaire
The research was undertaken using a questionnaire which was developed based on the studies of Guthrie et al. (1999), Guthrie et al. (2004) and Oliveras et al. (2004). The initial questionnaire was piloted for clarity, relevance and completeness on five business lecturers, two practicing accountants and three MBA students. The first part of the questionnaire consisted of questions on the availability of the 46 IC line-itemsof information measured on a 7-point scale. The list of 46 IC line-items from human capital, customer capital and structural capital in Appendix 1 was adopted from Huang et al. (2007) who initially founded their work on those established by Guthrie et al.(1999), Guthrie et al. (2004) and Oliveras et al. (2004) and tested on Malaysian data. The manager in each company was asked to indicate the extent of availability of IC information in their companies from “1” to “7” where “1” represents “none” and “7” represents “comprehensive”.
The second part of the questionnaire consisted of the contingency factors such as environmental uncertainty, competitive strategy, technological advancement, etc. which are elaborated below. An open ended question was added to the questionnaire where the respondents were asked to state whether there is any other IC information which is produced in their companies that is not incorporated into the questionnaire.
Usable Questionnaires, Response Rate, Non Response Bias and Reliability
Incomplete or partially completed questionnaires were discarded and 88 usable questionnaires were used for data analysis, giving a response rate of about 17% (88/520).
A non-response bias test was conducted on the data, using late responses as proxies for nonresponses. Results of the Mann Whitney U Test (see Appendix 2) show that there is no significantdifferencebetweenearly and late replies in their responses on the availability of internal IC information.
Cronbach’s Alpha coefficient of internal consistency was computed to check the reliability of the IC data. A scale is internally consistent if the items correlate highly with each other. In this case, they are also more likely to measure the same homogenous variable and items are more likely to satisfy these requirements if they are reliable. The outcome of the Cronbach’s Alpha test in Table 2 shows that the different categories of IC information are consistent. Their Cronbach’s Alphas are above 0.8. As the values of Cronbach’s Alpha were high, no item was eliminated.
Table 2: Reliability Test on of
Human Capital, Customer Capital and Structural Capital Information
Cronbach’s Alpha / No. of ItemsHuman Capital / 0.899 / 15
Customer Capital / 0.914 / 15
Structural Capital / 0.931 / 16
Developing an A Priori Model and Hypotheses
In this study, various explanatory variables were identified from previous contingency research to explain management accounting practices. Additionally, other variables used were thoserelated to the external provision of IC information. Variables which were used in this research are spelled out in the literature below.
External environment or environmental uncertainty
The external environment of an entity is described as either certain or uncertain, static or dynamic, simple or complex, and turbulent or calm (Fisher, 1995). Perceived environmental uncertainty has been identified as an important variable influencing management structures (including information systems) as it makes managerial planning and control more difficult (Duncan, 1972). Organisations facing high environmental uncertainty generally use and rely more on sophisticated control systems. Planning becomes problematic in uncertain operating situations because of the unpredictability of future events, and control activities are also influenced by uncertainty (Chenhall and Morris, 1986). As decision makers perceive greater uncertainty in the environment, they are likely to institute information systems that help them to cope with the perceived uncertainty (Gordon and Miller, 1976).
In a situation with high environmental uncertainty, financial data alone will not adequately reflect managerial performance, whereas such data would be adequate for a situation with low environmental uncertainty(Drury, 2004). Gordon and Miller (1976) too argue that organisations facing greater environmental uncertainty require more extensive, frequent and detailed financial and nonfinancial information and relatively sophisticated cost accounting and control systems. In line with this, Gordon and Narayanan (1984) and Chenhall and Morris (1986) provide evidence to suggest that the greater the perceived environmental uncertainty, the greater the decision making information such as non financial and future oriented information is needed. This supports the need for a wider scope of IC information under environmental uncertainty.
According to Claycomb et al. (2001), when demand unpredictability, product obsolescence and technological change are high, successful companies are those which continuously create and apply new knowledge to products and processes. In order to obtain new knowledge, more IC information is needed. In this study, environmental uncertainty was identified from six variables which relate to the demand for the product/service, competitors’ actions, technology, workforce expertise, product development, and benefits of R&D expenditure. These six variables were first developed by Chenhall and Morris (1986) and have been used in various subsequent studies to capture environmental uncertainty. The respondents were asked to respond on a 7-point scale (where ‘1’ represents ‘extremely stable’ and ‘7’ represents ‘extremely unstable’) in respect of each of the dimensions of uncertainty concerned. In line with prior research using this measure, the six variables were consolidated into a single construct representing environmental uncertainty. The survey questions related to this item were based on those used in prior research and hence have construct validity. Following Chenhall and Morris (1986), the scores were averaged to produce this construct.
The alternative hypothesis related to this variable is summarised as:
H1: There is a positive relationship between the availability of internal IC information and environmental uncertainty.
Competitive strategy or business strategy
Strategy is described as ‘the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action, and the allocation of resources necessary for carrying out these goals’ (Chandler, 1962, p. 13). According to Chenhall and Morris (1986), substantial changes in the nature and intensity of competition force firms to determine and measure the nonfinancial ‘value drivers’ leading to success in the new competitive environment. As IC information is qualitative and more useful for looking forward, its availability within Malaysian companies is expected to increase as the competitiveness intensifies.
Porter (1980) sees competitive strategy concerning with creating and maintaining a competitive advantage in each and every area of business. Heclassifies businesses based on their strategies as having either low cost strategies or product differentiation strategies. A firm with a low cost strategy offers relatively standardised, undifferentiated products with an attempt to obtain high volume and routinised tasks to exploit economies of scale. A product differentiation strategy attempts to innovate and offer something which customers perceive as unique and valuable. Porter (1980) suggests that a differentiation strategy requires strong coordination between various functions and subjective performance measurement and incentives instead of quantitative measures.
In this research, Porter’s strategy is examined across the whole range of a company's products to determine whether the company is prone to cost leadership or product differentiation. It is hypothesised that there is more internal IC information in companies which have strategies oriented more towards product differentiation.
H2: There is greater availability of internal IC information in companies with the product differentiation strategy than those with the cost minimisation strategy.
Technological advancement
Otley (1980b) states that production technology has an effect on the type of accounting information that should be provided. As this paper focuses on IC rather than management accounting or management control systems, it is appropriate to examine technology from a different perspective. Investments in information technology should enhance the management control systems. In effect, more IC information should be available in these companies.
Intangibles are especially vulnerable to rapid technological changes (Pitkanen, 2007). Chen et al. (2005) too suggest further investigation should be made on the role of IC in different emerging economies where different technological advancements may bring different implications for the valuation of IC (implying the need of IC information). El-Bannany (2008) also found that there is a significant association between investment in IT systems and IC performancein UK banks. Technology from three dimensions: customer service, information system and manufacturing technology were separately identified as potentially important in relation to the development of IC. Respondents were asked in the questionnaire to indicate their company’s extent of technological advancement in the past five years as regards to customer service, information systems, and manufacturing technology. It is hypothesised that there will be greater internal IC information in companies with more technological advancement in three dimensions.