Value of Internally Generated Intangible Capital

Abstract

Internally developed intangibles are not included in reported assets under U.S. GAAP. Omission of this increasingly important class of assets reduces the usefulness and relevance of financial statement analysis, conducted with book values of assets and equity. Recent studies attempt to overcome this deficiency by capitalizing selling, general, and administrative (SG&A) expenses, based on a one-size-fits-all mechanical rule of thumb that (i) treats a uniform 30% of SG&A as investments; and (ii) assumes the same life of SG&A investments across all industries. We estimate investment and maintenance portions of research and development (R&D) and MainSG&A (SG&A minus R&D), and their amortization rates, on an industry-year–specific basis. Our modified book value, inclusive of capitalized intangibles, exhibits greater association with future returns, investments, and bankruptcies, relative to as-reported and mechanically estimated book values. We provide a better estimate of book values of assets and equity for consumers of financial statements.

Keywords: Intangibles, Book Value, Financial Statement Analysis, Valuation

JEL Classification: M21, M41