I. ULUSLARARASI ENTELEKTÜEL SERMAYENİN ÖLÇÜLMESİ VE RAPORLANMASI SEMPOZYUMU

1. I. ULUSLARARASI ENTELEKTÜEL SERMAYENİN ÖLÇÜLMESİ VE RAPORLANMASI SEMPOZYUMU INTELLECTUAL CAPITAL: CAN IT BE AN ALTERNATIVE INVESTMENT STRATEGY IN CAPITAL MARKETS? Associate Professor Serhat YANIK Assistant Professor Basak TURAN ICKE Research Assistant Yusuf AYTURK Istanbul University, Faculty of Political Sciences

2. Presentation Outline • Introduction and Problem Definition • Intellectual Capital • Value Relevance of Intellectual Capital • Reporting of Intellectual Capital and Market Efficiency • Research Methodology and Data Description • Portfolio Formation Methodology • Value Added Intellectual Capital – VAIC • Main hypothesis • Results of Analysis • Conclusion and Implications YANIK, ICKE and AYTURK Istanbul University

3. Introduction and Problem Definition • In today’s business environment, the main aim of any company is to maximize the shareholders’ value. In value creation, firms use cash generating assets. These are tangible and intangible assets. In the knowledge age, intangible assets are more important than the tangibles for the value creation in firms. • Intellectual capital is a special kind of intangible asset. According to the widely accepted definition of intellectual capital, it refers to the sources of non-physical (added) value for a company or organization: human capital (e.g. skills, experience, training etc.), relational capital (e.g. customer and stakeholder relations, brands, agreements) and structural capital (e.g. company culture, working environment, systems, immaterial rights) (Stahle et al., 2011, p.532). YANIK, ICKE and AYTURK Istanbul University

4. Introduction and Problem Definition Table 1: The components of intellectual capital YANIK, ICKE and AYTURK Istanbul University

5. Introduction and Problem Definition • Mouritsen (1998, p.462) points out that intellectual capital is broad organizational knowledge unique to a firm, which allows the firm constantly to adapt to changing conditions. Intellectual capital can be accepted as a competitive advantage for the company and it is a key factor in value creation and increases free cash flows in any firm. • In the literature, value relevancy of intellectual capital has been analyzed in numerous studies by using different intellectual capital metric. • Chen et al. (2005) found a positive relationship between market value and intellectual capital by using Taiwanese data set. YANIK, ICKE and AYTURK Istanbul University

6. Introduction and Problem Definition • Kamath(2008) analyzed value relevance of intellectual capital for Indian pharmaceutical firms and found that intellectual capital does not explain market valuations of firms. • Vafaei et al. (2011) also examined the value relevance of intellectual capital disclosures by using data set covered the listed companies in Britain, Australia, Hong Kong and Singapore. Their results revealed that intellectual capital disclosure is positively associated with market prices of limited number of companies in the study. • Wang (2008) examined the relationship between intellectual capital and market value in US for listed electronic companies in Standard & Poor’s 500 Index. YANIK, ICKE and AYTURK Istanbul University

7. Introduction and Problem Definition • Calisir et al. (2010) found no significant relationship between market valuation (P/B Ratio) and intellectual capital for Turkish ITC firms. • Yalama and Coskun (2007) investigated intellectual capital performance of banks listed in Istanbul Stock Exchange by using data envelopment analysis and found that the portfolio constructed based on IC has the highest return. YANIK, ICKE and AYTURK Istanbul University

8. Introduction and Problem Definition • Intellectual capital is the most important asset in any firm in cash flow generating process. In an efficient stock market, this information must be evaluated and reflected into market prices of listed companies. Otherwise, a profit opportunity not priced in the market appears and investors can gain excess returns. • In this respect, some studies investigated the relationship between intellectual capital and stock returns. • Pantzalisand Par (2009) measure human capital intangibles (EVHC) of firms and construct portfolios of low EVHC firms and portfolios of high EVHC firms. • Hurwitz et al. (2002) investigated the relationship between intangibles performance and stock returns. YANIK, ICKE and AYTURK Istanbul University

9. Introduction and Problem Definition • Degree of intellectual capital is an important indicator of subsequent financial performance of companies. Investing in intellectual capital affects the long-term cash generating capability of companies. • Intellectual capital information is not reported directly by Turkish publicly held companies. However, analysts can easily access such information by interviewing with company managers or calculating widely used VAIC metric from annual reports. • Intellectual capital information is required to be reflected in market prices in an efficient market. Efficient markets hypothesis states that all publicly available information on common stocks is already reflected in current prices and any strategy cannot beat the market (generating abnormal returns above the market index). YANIK, ICKE and AYTURK Istanbul University

10. Introduction and Problem Definition • In this study, we examine the relationship between stock returns and intellectual capital levels of Turkish publicly held companies. • Following a portfolio formation methodology, we construct two equity portfolios depending on the VAIC metrics of each company listed in ISE 30 Index to analyze whether high VAIC portfolio outperforms the market index and/or low VAIC portfolio. YANIK, ICKE and AYTURK Istanbul University

11. Research Methodology and Data Description • In this paper, we investigate whether common stocks with higher intellectual capital can beat the market and whether common stocks with higher intellectual capital outperform lower intellectual capital. We test our hypotheses by using a portfolio formation and performance evaluation research methodology. • Each April, following the announcement of last year financial statements of the listed firms in Istanbul Stock Exchange (ISE), we form two different investment portfolios based on VAIC metrics of blue chip firms listed in ISE 30 Index. YANIK, ICKE and AYTURK Istanbul University

12. Research Methodology and Data Description • We restrict our sample to only blue chip firms rather than including all the firms in ISE because of the data limitation. We test our hypothesis especially for institutional investors. In Turkey, institutional investors (mutual funds, pension funds and banks) primarily invest in blue chip firms as equity investing. Real estate investment trusts and holding companies are excluded. • After the formationof investment portfolios with the lowest and highest intellectual capital, we calculate equally weighted monthly returns of these portfolios during the following year. This investment strategy is followed for the period 2006 – 2010 by using preceding year financial statements of the firms listed in ISE 30 Index. YANIK, ICKE and AYTURK Istanbul University

13. Research Methodology and Data Description YANIK, ICKE and AYTURK Istanbul University

14. Research Methodology and Data Description • One of the most popular intellectual capital metrics is Value Added Intellectual Capital (VAIC) developed by Pulic (1998, 2000, and 2004). This metric can be practically applied by using only financial reports of a business which makes VAIC metric widely used in the literature. • VAIC = HCE + SCE + CEE VAIC: Value Added Intellectual Capital HCE: Human Capital Efficiency SCE: Structural Capital Efficiency CEE: Capital Employed Efficiency YANIK, ICKE and AYTURK Istanbul University

15. Research Methodology and Data Description • We compared the performance of equally weighted portfolios to the performance of a benchmark portfolio (ISE 100 Index and ISE 100 Index-based mutual fund).  • We adjust the monthly returns of portfolios according to the market model. The regression equation used in the market model is stated below; ri,t – rf,t = αi + βi (rm,t – rf,t) + εi,t • [rm,t – rf,t] is the market’s excess return over the risk-free rate of return.The risk-free rate of return (rf,t) is the rate of GDS Repo Index’s monthly return. [ri,t – rf,t] is portfolio’s excess return over the risk-free rate of return. The intercept term αiis supposed to capture the abnormal return unexplained by exposure to market risk factor. The slope βi is the only systematic risk factor beta coefficient. εi,t stands for residuals. YANIK, ICKE and AYTURK Istanbul University

16. Research Methodology and Data Description • In an efficient market, there must not be any positive αi generating portfolio or investing strategy. Generating positive αi means beating the market. In this respect, we test whether higher VAIC portfolio beats the market. Our main hypothesis is stated below; H0: Higher VAIC portfolio does not beat the market; αHVAICP = 0. H1: Higher VAIC portfolio beats the market; αHVAICP ≠ 0. • After testing our main hypothesis, we also compare the portfolio performance measures of high and low VAIC portfolios. YANIK, ICKE and AYTURK Istanbul University

17. Results of Analysis YANIK, ICKE and AYTURK Istanbul University

18. Results of Analysis YANIK, ICKE and AYTURK Istanbul University

19. Results of Analysis • Raw returns are not used in performance evaluation of portfolios since raw returns ignore the risk characteristics of the portfolios. • For a better performance evaluation of high and low VAIC portfolios we also estimate widely used market model and calculate Jensen’s Alpha, Sharpe, Treynor and Information ratio ratios. YANIK, ICKE and AYTURK Istanbul University

20. Results of Analysis YANIK, ICKE and AYTURK Istanbul University

21. Conclusion and Implications • The results prove that intellectual capital efficiency as the main cash generating source in a company is reflected into market prices of Turkish blue chip firms during the period 2006 – 2011. • A strategy investing in Turkish blue chip firms with high intellectual capital does not make any abnormal return. Our findings are consistent with efficient markets hypothesis. • When we compare the performance results of two different portfolios (high and low VAIC portfolios), high VAIC portfolio obviously outperforms low VAIC portfolio. • Sharpe, Treynor and Information ratios of high VAIC portfolio is higher than low VAIC portfolio’s. This finding is also consistent with value relevance of intellectual capital. YANIK, ICKE and AYTURK Istanbul University

22. Thanks for your listening YANIK, ICKE and AYTURK Istanbul University