(5 min read)
For decades, economists have understood that the market valuation of a company is quite different from its official book value. Baruch Lev (2001) observed that for every $6 in market value only $1 is recorded on a formal balance sheet. More recently McGuire and Brenner (2015) make the similar distinction between what they call enterprise value and book value, with the difference being unrecorded intangible assets such as brand, customer relationships, patents, internal processes, and quality of management. Furthermore, they created an Intellectual Capital Index (ICI) that shows that approximately 80% of the market value of a company is comprised of intellectual capital. While some dispute the 80% split for intangibles as being too high, the author’s sample of companies across various industries shows that it does pertain. Even if this debate continues, intangibles are still very significant and represent a large percentage of market value.
The market valuation of a company is dependent not just on people’s “know-how,” but also their “know-who.” Click To Tweet
This research is not simply an academic exercise because these findings have now made their way from the classroom to the boardroom. New audiences, such as investment bankers, financial analysts and, most importantly, Boards of Directors, understand the message that most of the value of companies is driven by human capital. These new audiences predictably want more information and data on the strength of intangibles, because they are being held accountable themselves. They also want to focus the executive management team on maximizing this often illusive asset. The C-Suite is more responsive than ever because their bosses understand the market valuation equation.
It is impossible to underestimate the importance of these findings for the HR profession.
The growing acceptance that people-driven intangibles provide real value and competitive differentiation has provided HR with the opportunity to drive business results and lead. The growing recognition that the “soft stuff is really the hard stuff” simply would not have happened without these new audiences—especially Boards of Directors– getting involved and demanding results. It is hardly surprising, then, that a recent Conference Board study of global CEOs finds that human capital challenges are their top priority.
Even before the work of Baruch Lev, many observers took notice that the market valuation landscape was changing when IBM acquired the Lotus Corporation in 1995. Lotus was a Cambridge, Massachusetts-based software company, and its main products were Lotus 1-2-3 (a spreadsheet) and Lotus Notes (a client server collaboration tool). IBM paid $3.5 billion for the Lotus acquisition, and many were surprised at the amount; IBM’s bid doubled the current Lotus stock price at the time. But IBM wasn’t buying Lotus for its tangibles and physical assets; it was all about the talent and its ability to develop new products and markets. This practice—now known as acquihiring— continues today, especially in the high tech and pharmaceutical industries.
There is another chapter to this story on market valuation: it is the unsung asset and the key to intangible asset growth. Intangible assets will erode and even disappear unless cultivated and grown; and if this happens, market valuation declines commensurately. So, the critical question becomes: how can intellectual capital be grown and further developed? One logical way to grow human capital is to invest in further developing people’s knowledge, skills and abilities. These developmental programs are essential and must be done, but these efforts can take time and are hard to scale.
The unsung asset for improving intellectual capital is right in front of us and routinely ignored. It is having access to the human capital of others by intentionally building stronger and more extensive professional networks. This unsung asset is referred to as social or relational capital.
Seth Godin has rightly observed that value in this economy is about connections and relationships. Those with the strongest connections, win. IBM has shown that people with more extensive professional networks are 15% more productive because they tap their networks for advice, wisdom, and lessons learned.
If you want to know a fact, Google it; if you want advice and insight, talk to people in your network.
Access to the tacit knowledge of others is a huge asset that is too rarely leveraged. The wisdom of the crowd, as it turns out, is probably the most valuable of all assets. It enables HR to be the connective tissue of an organization and the “force-multiplier.” As the great Satchel Paige observed, “Ain’t none of us as smart as all of us.”
If you follow the linkage, the market valuation of a company is dependent not just on people’s “know-how” but also “know-who.” The former is what we must do to ensure that employees continue to have the right skills and abilities in a dynamic business environment. The latter is how you marshal these resources, gain access to deep-seated insight and build organizational capability. It’s the connections that probably matter most.