Int. J. Learning and Intellectual Capital, Vol. 5, Nos.

3/4, 2008 431

The value relevance of human capital, corporate

governance and intangible assets in growth
enterprises: evidence from Hong Kong

Artie W. Ng
School of Professional & Executive Development
Public Policy Research Institute
The Hong Kong Polytechnic University
Hung Hom, Hong Kong
E-mail: spartie@speed-polyu.edu.hk

Abstract: This article attempts to investigate the value relevance of intangible

assets, human capital and corporate governance disclosed in the Initial Public
Offer (IPO) prospectuses of growth enterprises in Hong Kong. Prior studies
have explored the relevance of prospectus earnings forecasts for investors and
the determinants of the accuracy of such estimates.1 However, for enterprises
that advance with dependence on new knowledge and technological innovation
in emerging business sectors, recent studies have suggested the value relevance
of intangible assets2 and other intangible factors, namely, human capital and
corporate governance. The experience of growth enterprises that went through
an IPO in Hong Kong provides an independent source of evidence for the
exploration of the value relevance of such intangible factors. Through the
analysis of the disclosed information of 214 growth enterprises, this study
confirms the significance of specific components of these intangible factors
and an integrative relevance of financial and nonfinancial information on
Value Sustainability (VS). It argues that the regulator’s enforcement on
adequate disclosure and accounting treatment, pertinent to the recently
harmonised reporting standard to uncover the underlying fundamentals of a
listing candidate, is more critical than solely pinpointing its corporate
governance disclosures.

Keywords: intangible assets; intellectual capital; human capital; corporate

governance; valuation; information asymmetry; growth enterprises;
Hong Kong.

Reference to this paper should be made as follows: Ng, A.W. (2008)

‘The value relevance of human capital, corporate governance and intangible
assets in growth enterprises: evidence from Hong Kong’, Int. J. Learning and
Intellectual Capital, Vol. 5, Nos. 3/4, pp.431–454.

Biographical notes: Dr. Artie W. Ng is a Senior Lecturer with the School

of Professional and Executive Development of the Hong Kong Polytechnic
University and an Honorary Fellow with the Public Policy Research Institute
of the same institution. He is an active researcher on interdisciplinary
management issues that are pertinent to performance measurement systems,
intellectual capital and enterprise risk management.

Copyright © 2008 Inderscience Enterprises Ltd.

432 A.W. Ng

1 Introduction

Emerging enterprises that seek growth through leveraging on intellectual property and
technological innovation are found to depend on certain intangible factors. In studying
the sources of business opportunities that are exploited by entrepreneurs, Drucker (1985)
pointed out that knowledge-based innovation was the ‘superstar’ of entrepreneurship.
Such innovation was driven by technical applications, scientific initiatives and social
developments, but also involved challenges under certain time spans and complexity with
the convergence of new technologies. This sort of entrepreneurial development process
could be considered more difficult to manage than conventional businesses. It was noted
that this particular risk could be mitigated through timely integration with the new
knowledge adopted as the source of innovation.
In recent years, global competition has been increasingly driven by continuous
innovation among knowledge-intensive enterprises that, in turn, seek sustainable growth.
Jaruzelski et al. (2005) reported that corporations had constantly increased investments in
Research and Development (R&D) expenditures; it was observed that companies with
more intangible assets, such as patents, tend to have better performance in terms of
business growth and market capitalisation. Even developing nations, such as China and
India, have increased in the recent years their resource allocations into R&D, with an
average growth rate of 21.1%.
As investigated by Lev and Sougiannis (1996), companies’ expenditures in R&D
(if capitalised) would provide value-relevant information to investors, since such
adjustments were unveiled to be ‘statistically reliable and economically meaningful’ in
predicting future stock returns. Moreover, the corporations listed in the USA that
managed to successfully develop patents from their investments in science and
technology were found to excel in terms of stock returns and market-to-book ratios (Deng
et al., 1999). In fact, the value relevance of R&D was found to be significant in Korea, as
well (Han and Manry, 2004). Recent research in intellectual capital placed significant
emphasis on the impact of the intellectual capital elements on business performance,
building on prior studies about the cause-effect perspective among the components of
intellectual capital.3
Surveying over 500 senior executives who had successfully gone through the process
of Initial Public Offer (IPO), Mavrinac et al. (2002) remarked that the underperformance
of their companies was caused by failure in the development of corporate intangibles and
measurement systems. The three most important capabilities to sustain performance were
found to be innovative product development, management credibility and effective board
oversight. In predicting the survival of the high-technology firms that have gone through
IPO, Wilbon (2002) investigated the survival of a group of technology-based firms and
found that those which managed to survive possessed more experienced senior executives
and more intellectual property rights than those which did not.
Although there has been an increasing reliance on intangible assets to sustain growth
among these knowledge-intensive enterprises, conventional financial reporting standards
tend to be designed for reporting on traditional enterprises under steady operations and
to take a conservative approach when dealing with transactions involving uncertainty.
The technology-based companies that grow and develop under a changing business
environment, as well as the uncertain influence of emerging and disruptive technologies,
would substantiate a conservative approach in financial reporting. The reported financial
information alone might not be able to reflect the sufficient usefulness and relevance
 The value relevance of human capital 433

the stakeholders in making assessments. This dilemma could create problems that for
are associated with information asymmetry among these new knowledge-intensive
companies, as pointed out in previous research (Aboody and Lev, 2000).
Nevertheless, the International Accounting Standards Committee (IASC) responded
to the growing need to report on intangible assets and related disclosures with the
issuance of IAS 38, the standard that provides the guidelines for the capitalisation of
intangible assets. Accordingly, only the intangible assets that are demonstrated to meet
the following criteria could be capitalised and recognised at cost:
• the assets meet the definition of an intangible asset, i.e., it is identifiable and
controlled by the entity
• it is probable that the future economic benefits that are attributable to the asset will
flow to the entity
• the cost of the asset can be measured reliably.
The Hong Kong Institute of Certified Public Accountants (HKICPA), the statutory
professional accounting body of Hong Kong, pronounced its HKAS 38 on reporting
intangible assets in 2004, which was based on the principles of IAS 38 (HKICPA, 2005).
Disclosures on intangible assets alone, however, seem insufficient for growth
enterprises. Exploring the characteristics of intangible assets, other researchers have
looked into the development of an intellectual capital framework that aims to improve the
reporting and measurement of intangible assets. In particular, researchers have pointed
out two factors that are increasingly influential on corporate performance: human capital
and corporate governance. For young enterprises, the factor of management capability
has been noted as a key determinant for successful growth and development.4 On the
other hand, corporate governance has been viewed as a key element in enhancing the
performance of companies globally and in Asia. Ho and Williams (2003) attempted
to explore the underlying relationship between board characteristics and corporate
performance across the selected countries. Filatotchev et al. (2005) noted institutional
investors’ positive influence on the financial performance of Taiwanese-listed companies
through board participation.
Embracing the potentials in technology-based ventures in the ‘new economy’, the
Growth Enterprise Market of the Stock Exchange of Hong Kong (GEM, 2005) was
established towards the end of the 20th century. GEM was designed to be a distinctive
stock exchange block from the Main Board of the Stock Exchange of Hong Kong
(SEHK) for the capital raising of promising growth enterprises in Hong Kong and its
adjacent regions. The listing rules of GEM are more liberal than that of the Main Board,
in terms of the requirements on past performance, with an attempt to enable young
enterprises to gain easier access to equity financing through the GEM platform. However,
weak disclosures and the quality of corporate governance among the GEM companies
have been argued to deteriorate their sustainability of value. Despite criticisms about the
failures among the GEM companies, the SEHK lingers on in its ‘business-as-usual’
mode.5 Recommendations by the professional accounting body in Hong Kong are made
particularly to raise the requirements on disclosures and their corporate governance
practices;6 however, little attention is paid to the importance of the disclosures about their
intangible qualities.
434 A.W. Ng

Unlike the companies seeking IPO on the Main Board, the GEM companies rarely
provide earnings forecasts in their prospectuses. In fact, disclosing information about a
future earnings forecast is only a voluntary act. The listing rules do not require historical
profit-making among the GEM listing candidates and most of them have rather short
operating histories. Furthermore, the business uncertainty that is faced by these young
enterprises may perplex the task of preparing a reliable profit forecast.
Potential investors can no longer rely on the traditional disclosure of a one-year profit
forecast as a critical piece of information for assessment, as the preparation of such
estimates by the GEM listing candidates is less feasible than by those of the Main Board.
The relevance of using prospectus profit forecasts, as explored in prior studies,7 to assess
the future prospects of GEM companies becomes questionable.
Although improvement in corporate governance is currently underscored by the
regulator to enhance the performance of the GEM companies, disclosures on key
intangible factors should arguably be given equal emphasis for their implication in the
future sustainability among growing knowledge-intensive enterprises, as confirmed in
prior international studies. As such, this paper is rationalised to explore the three
seemingly relevant intangible factors – intangible assets, human capital and corporate
governance – with respect to their value relevance among the GEM listed companies.
Through the examination of their disclosures on reported intangible assets, human capital
and corporate governance characteristics in prospectuses, this study attempts to reveal
the influence of these three core factors on the Value Sustainability (VS) of the
GEM companies after IPO. It also attempts to investigate the predictive performance
of intangible qualities in replacement of the determinants for a traditional one-year
earnings forecast.

2 Literature review
2.1 The relevance of prospectus earnings forecasts
Prior studies on the prospectus disclosures by companies in Hong Kong unveiled the
accuracy of the earnings forecasts prepared by IPO candidates for the Main Board of the
SEHK (Chan et al., 1996; Jaggi, 1997). The studies investigated the usefulness of such
forecasts to potential investors in assessing the future prospects of the companies to be
listed. Such earnings forecast information was largely concluded to be accurate, implying
its relevance and usefulness to the equity stakeholders in predicting the future
performance. In these two studies, determinants such as the past profit variability and the
years in business were found to be significant in influencing the accuracy of the estimated
earnings. However, the future prospects of these listed companies, subsequent to meeting
their first-year earnings forecast, were found questionable (Chan et al., 1996).

2.2 The value relevance in knowledge-based entrepreneurial enterprises

Pioneering the study of the value relevance of intangible assets, Lev and Sougiannis
(1996) explored the accounting treatment of R&D expenditures in a large sample of
public companies that are listed in the USA. The study revealed a significant
intertemporal association between firms’ R&D capital and the subsequent stock returns.
It also pointed out the significance of underreaction to the R&D investments made
 The value relevance of human capital 435

by a firm. Revealing the phenomenon in the wireless communications industry, Amir and
Lev (1996) further identified the importance of using the nonfinancial information
reported by companies within a technology-based industry to assess their subsequent
financial performance, since its combination with financial information would create
complementarity for a well-rounded assessment. As explored by Deng et al. (1999),
strong capabilities and investments in the science and technology possessed by
companies were found to have a positive impact on their future performance in the
capital market. These companies were able to successfully develop patents from their
investments in R&D, which also stimulated their productivity and growth.
Furthermore, Lev (2004) pointed out that the return from investments in R&D
activities did require a prolonged timeframe, as the effect of delivering new products and
the improvement of operational efficiency led by R&D expenditures would take years to
realise. Since the R&D expenditures that might have been recognised as intangible assets
were mostly recorded as expenses in the fiscal year that they were incurred, such
expenses would burden the technology firm with worsened financial earnings and cause
undervaluation in the capital market. Despite such a short-term effect, firms with heavy
R&D investments were demonstrated to be underpriced, but they were able to outperform
the market in later years.
Extending similar studies to the Korean stock market, Han and Manry (2004)
investigated the value relevance of R&D in the listed companies in Korea and indicated
that R&D expenditures were positively associated with stock prices; capitalised R&D
expenditures would produce even more economic benefits, whereas advertising expenses
were inversely related to the future stock price. More recently, a case study of Canadian
wireless technology companies confirmed the influence of the resources allocated into
R&D combined with infrastructural assets on the generation of revenues during their
early growth and development (Ng, 2006).
In fact, recent research in intellectual capital attempt to integrate the issues of
measuring and reporting intangible assets into a framework of study. They place
significant emphasis on the impact of intellectual capital elements on business
performance, building on prior studies about the cause-effect perspective among the
components of intellectual capital. Some explored the development of an intellectual
capital framework to integrate the important issues in the measurement and reporting of
innovation capital, human capital, structural capital and customer capital.
To explore the interrelationship among the elements of intellectual capital from the
experience of Taiwan, regression analysis was adopted to understand such a dynamic
relationship and the impact on market-to-book value ratios and the future financial
performance (Chen et al., 2005). Huang and Liu (2005) used a comparable approach to
explain the impact of innovation capital and Information Technology (IT) capital on firm
performance. The research concluded that investments of innovation capital would have
a positive effect on performance before an optimal point, beyond which the influence
of innovation capital on performance could become negative. In addition, it was shown
that the interaction between innovation capital and IT capital would create a positive
influence on firm performance. For the IT industry in Taiwan, research efforts were also
made on the causes and effects of intellectual capital on business performance; the results
also indicated a significant impact of innovation capital on customer capital and,
subsequently, on business performance (Wang and Chang, 2005).
436 A.W. Ng

To investigate the advantage of reporting based on the intellectual capital approach,

Mouritsen (1998) examined the differences between the Economic Value-Added (EVA)
and intellectual capital measurement in the reporting of business performance. The study
pointed out that EVA tended to focus on financial measurements with reference to the
cost of capital and bottomlines. Intellectual capital measurement appeared to relate to
nonfinancial elements (such as organisational knowledge and competence development)
and thereby encouraged endogenous growth and the creativity of employees.

2.3 The value relevance of human capital in growth enterprises

Human capital development within organisations was identified as a key factor for their
survival and sustainability under vigorous business competition. Former studies on
knowledge management pointed out the significance of human capital as the core
competence of organisations. The continuous development of human capital and the
associated organisational capital could be enhanced through knowledge sharing and
experiential learning; the knowledge development life cycle had to be maintained in order
to generate sustainable growth for a company (Gamble, 2001).
In fact, intangible assets were presumably a critical consideration not only for
large enterprises, but also for new ventures. For startup businesses, Pena (2002)
found that the human capital of entrepreneurs, organisation capital and relational
capital – such as strategic business networks and relationships with stakeholders – were
important intangible assets which had a positive relationship with venture performance.
Although the availability of tangible assets and financial resources is a concern,
intangible assets play a strong role in contributing to the growth of a startup company.
Human capital should comprise the entrepreneurs’ education, business experience and
level of motivation.
Abeysekera and Guthrie (2004) pointed out the emerging importance of reporting on
information other than ‘financial’ data, in particular, on human capital management, as
external stakeholders demand additional disclosures. Through content analysis, the
researchers explored the difference in human capital reporting between developed and
developing nations and found that developed countries tended to focus more on the
process-driven information about human capital, such as work-related knowledge.

2.4 Corporate governance as a value-relevant factor

For the case of Hong Kong, subsequent to a number of failures among the young
enterprises that are listed on GEM, critics suggest that corporate governance is a deficient
element among the GEM-listed companies and the rectification of the board structure is
needed (Wong, 2004). To study corporate governance among entrepreneurial firms, Daily
and Dalton (1992) examined the organisational agent and firm performance linkage,
focusing specifically on the role of founder CEOs and the composition of the boards of
directors. The study found that a CEO’s ability to forgo some measure of control by
inviting outside directors into the board might contribute to the overall performance and
growth of these firms. Despite the fact that it was unlikely that there would be an optimal
board configuration that would effectively lead the entrepreneurial firm to success,
making use of the expertise and resources provided by outside directors could facilitate
healthy growth.
 The value relevance of human capital 437

Other studies were launched to explore the importance of the board structure in
influencing corporate performance (Ho and Williams, 2003; Khurana, 2003). The
experience among the listed companies in Taiwan suggested that share ownership by
institutional investors was positively associated with strong financial performance;
coalition among the critical block-holders in a board would also enhance performance
(Filatotchev et al., 2005). The study pointed out the importance of power sharing and the
potential value of interaction between different types of directors and, therefore, board
dynamics. Nevertheless, the particular management culture that is influenced by lingering
Chinese tradition may have an impact on the growth and development of an
entrepreneurial firm that requires timely innovation. As studied by Chan et al. (2001), a
management control system within a Chinese setting tends to be power-centric among the
owners in terms of decision-making and the authorisation of transactions; such a practice
appears to be contradictory to the need for a delegated and interactive performance
management system that facilitates innovation.
In a research study about corporate governance and innovation in entrepreneurial
firms, Markman et al. (2001) pointed out that substantial information asymmetry
between entrepreneurs and their investors is caused by the complicated business nature of
cutting-edge innovation projects. Such a complication is further perplexed by the
business uncertainty that is associated with young firms. The authors suggested the
development of a governance system to enable the effective monitoring of ventures and
to facilitate the alignment of interests between entrepreneurs and investors.

2.5 Information asymmetry

For entrepreneurial enterprises, information asymmetry has been considered an intrinsic
problem in which management is unwilling to disclose sensitive information or the
method of exploitation that would induce competitive advantage over the other market
players (Shane, 2004). While the founders may be defensive about disclosing sensitive
business information, the resource providers need to be aware of the situations in which
the entrepreneurial management would negotiate with them in an attempt to generate
wealth at their economic expense when information about a venture is incomplete.
Furthermore, information asymmetry would create investment risks when the
entrepreneurial management becomes willing to take an excessive risk with the investors’
resources, making it a challenge to effectively monitor the management execution.
In studying the financing of business startups, Cassar (2004) reviewed the issues that
are related to information asymmetry and agency theory in the investigation of the
determinants of capital structure and the types of financing. The study revealed the
problems that financiers need to find ways to reduce the potential risks that are associated
with financing startups, given their little track record and the uncertainties with their
future performance. The results suggested the importance of delivering appropriate
signals of growth to the stakeholders and the need to establish a credit relationship as
early as possible.
More importantly, recent studies about the reporting and valuation of intangible
assets advocated an integrated approach in reporting intellectual capital and pertinent
disclosures for ‘value creation’, whereas traditional financial reporting provided measures
of ‘value realisation’ (Ordonez de Pablos, 2004; Roos et al., 2005). The reporting of
intellectual capital could mitigate the problems of information asymmetry that are
438 A.W. Ng

associated with traditional financial disclosures through effective illustrations of the

development of intangible assets within a company, as well as communications about
organisational values and competitiveness. In relation to the accounting treatment of
software development costs, Mohd (2005) found that the capitalisation of such costs in
accordance with Generally Accepted Accounting Principles (GAAP) requirements could
reduce the information asymmetry of companies within the software industry. However,
the author also pointed out that such recognition might fail to reduce information
asymmetry when management exploits capitalisation to manage earnings.

2.6 A relevant framework for assessing growth enterprises

Prior studies by Chan et al. (1996) and Jaggi (1997) on the prospectus disclosures by
companies in Hong Kong unveiled the accuracy of the earnings forecasts prepared by
IPO candidates for the Main Board of SEHK. The studies affirmed the usefulness of
these forecasts to potential investors in assessing the future prospects of the companies to
be listed. The studies also identified and confirmed the significant determinants for the
accuracy of forecasts. Such information was concluded to be relevant for the equity
stakeholders in assessing the potentials of these IPO candidates for the Main Board. In
these two studies, certain determinants, such as the variability of past profits and the
number of prior years in business, were found to be significant in influencing the
accuracy of such estimated earnings. However, a similar approach seems neither relevant
nor practical for the GEM IPO candidates.
To harmonise with the international accounting standards, HKICPA simulated the
IAS 38 with the pronouncement of the local standards: HKAS 28 for the reporting of
intangible assets in 2004, subsequent to the adoption of the Statement of Standard
Accounting Practice (SSAP) 29 in 2001. However, the introduction of the reporting
standard alone might not have been effective in ensuring relevant and complete
disclosures to potential equity stakeholders, given the unique characteristics of intangible
assets and the potential interrelationship among the intangible factors. Both the adequacy
of standard interpretations and reliance on voluntary disclosures for further details would
complicate the effectiveness of the implementation of the new standard. For instance,
Jaggi and Zhao (1996) reported on the gap between the awareness of environmental
performance and the actual environmental disclosures in Hong Kong under a voluntary
disclosure system. Similarly, the recent development of reporting standards for intangible
assets would imply that a process is involved to enable an effective acceptance and
implementation by the local companies. The capital-raising experience of the GEM
companies and their subsequent sustainability of value represents a case that deserves
exploration about the value relevance of intangible assets in light of prior pertinent
studies of other international capital markets.
More importantly, as it was argued that intangible factors, namely, intangible
assets, human capital and corporate governance, tend to be value-relevant to
knowledge-intensive companies, the exploration of the interrelationship between these
intangible factors and VS would facilitate responses to two important inquiries.
1 How useful and relevant is the information provided in the IPO prospectuses in its
current form for investors to assess the potentials of the GEM candidates, in the light
of the unavailability of profit forecasts? Arguably, the investors would have access to
improved disclosures if the reporting requirements on value-relevant intangible
factors could be identified, emphasised and detailed to reflect their criticalness.
 The value relevance of human capital 439

2 How relevant is an integrated reporting framework8 that emphasises the

interrelationship of innovation capability and human capital in predicting the
performance of the GEM companies? As an interdisciplinary approach has been
adopted to explore the framework of intellectual capital, the causal relationship
among the intellectual capital components can be explored to enable a better
analysis of the predictive performance for the investors. Such a linkage to the
measurement and reporting of the intangible qualities of knowledge-intensive
enterprises can be emphasised to enhance integration into the disclosure
requirements of the listed companies.

3 Methodology

With reference to the inquiries above, this research study utilises a set of hypotheses to
test the relevance of certain identified factors with respect to the sustainability of the
stock values of the GEM companies. In order to explore the significance of the possible
determinants in sustaining the value of the GEM companies, the metrics for VS are
derived and, subsequently, a set of hypotheses are developed.

3.1 Value sustainability

VS in this paper is defined as the ability of a GEM company to maintain its IPO offering
price after a time interval. The time interval adopted in this study (one year) is a
comparable benchmark in order to provide sufficient time to test the underlying
relationship with the independent variables that are used in the hypotheses. The VS is
calculated as follows:
VSi = MPi/IPi,
where:
VSi = the value sustainability of company i
MPi = the market price per share of company i, 12 months after the date of IPO
IPi = the IPO Offer Price per share of company i.

3.2 The development of the hypothesis

3.2.1 Years in business
Jaggi’s (1997) study confirmed the significance of the number of years that a company
had been in business as a determinant for the accuracy of the prospectus profit forecasts
among the companies listed in the SEHK. Although the GEM companies are not strictly
required to have certain years of prior business operations, a track record of their
past business performance may have a positive implication on a company’s future
sustainability. A similar hypothesis is therefore adopted:

H1 The longer a company’s operating history (YB), the stronger the value
sustainability (VS).
440 A.W. Ng

3.2.2 Net income growth

Chan et al.’s (1996) study concluded that a lower past profit variability would tend to
increase the accuracy of profit forecasts among the companies listed in the SEHK. While
the GEM companies typically have a rather short profit-making history, a track record of
their stable business performance may not be available. However, due to the expected
growth nature of the GEM companies, it would be worthwhile to investigate the
relationship between the change in net income in the year prior to the IPO and the
sustainability of value:

H2a The higher the net income growth (NIG), the stronger the value
sustainability (VS).
To further explore the relevance of Net Income (NI) in the valuation of the GEM
companies, the following hypothesis is adopted:

H2b The higher the ratio between net income and market capitalisation (NI/MC), the
stronger the value sustainability (VS).

3.2.3 The size of the company – the amount of capital raised and
market capitalisation
While both studies by Chan et al. (1996) and Jaggi (1997) suggested that a company’s
size should be considered a factor in determining the accuracy of profit forecast, both
studies failed to confirm its significance. However, the GEM companies, which are
typically in their early stage of growth and development, would require financial
resources to sustain their growth. A larger amount of raised capital may enable a
company to fulfil its capital requirements for growth. Therefore, the amount of capital
raised at IPO is assumed to have a certain effect on VS:

H3a The larger the amount of capital raised at IPO (CR), the stronger the value
sustainability (VS).
The listing requirements for the GEM companies state that a listing candidate needs to
have HK$150 million of market capitalisation at the time of listing. This particular
requirement implies the importance of the size of market value for the GEM companies.
The following hypothesis is used to test such a validity:

H3b The larger the amount of market capitalisation at IPO (MC), the stronger the
value sustainability (VS).

3.2.4 Intangible assets

A number of articles have confirmed the significance of R&D expenditures in supporting
the performance of companies in the market value, as well as the significance of
capitalised intangible assets in terms of value relevance (Lev and Sougiannis, 1996;
Deng et al., 1999; Han and Manry, 2004; Lev et al., 2005). The two following
hypotheses are developed to examine whether similar associations exist among the
GEM-listed companies:
 The value relevance of human capital 441

H4a The higher the R&D value intensity9 – R&D expenditures (IA1) as a fraction of
market capitalisation (MC), the stronger the value sustainability (VS).

H4b The higher the capitalised intangible asset value intensity10 – capitalised
intangible assets (IA2) as a fraction of market capitalisation (MC), the stronger
the value sustainability (VS).
Amir and Lev (1996) revealed the value relevance of nonfinancial information on the
companies in the wireless communication industry. Furthermore, as companies that
possess intangible assets would likely provide relatively more information about
intangible assets in their IPO prospectuses than those which do not, the following
hypothesis aims to examine the relationship between the extensiveness of the disclosures
on intangible assets and value sustainability of the GEM companies:

H4c The more extensive the combined disclosures on intangible asset information
(IA3),11 the stronger the value sustainability (VS).

3.2.5 Human capital

In studying the survival of high-technology firms that have gone through IPO, Wilbon
(2002) pointed out that those that managed to survive possessed more experienced
senior executives. On the other hand, Honig (2001) suggested a small relationship
between the years of work experience of nascent managers and their participation in an
entrepreneurial or corporate venture setting. The average years of work experience of
these managers was about 16. To explore the value relevance of human capital in terms
of management experience, it is worthwhile to examine the following hypothesis:

H5a The more the experience of management (HC1), the stronger the value
sustainability (VS).
Micheli et al. (2004) suggested that it is important to maintain a performance
measurement system with the right measures of performance that would drive expected
goals. The agents’ compensation should be contingent upon the performance measures
that are specified in the performance measurement system. Also, Elitzur and Gravious
(2003), through a model that applied game theory and the signalling problem, noted that
the moral hazard problem rises when the actions required or desired under the contracts
that are not freely observable would lead to a prisoner dilemma-like outcome. The free
rider phenomenon would also result from this inefficient behaviour. Such a problem
could be avoided through corporate governance and financing mechanisms, including
stock options, staged financing and direct oversight. The following hypothesis aims to
test the value relevance of stock options as a mechanism to enhance the human capital of
senior management:

H5b There is a correlation between the existence of a stock option programme (HC2)
and value sustainability (VS).
442 A.W. Ng

3.2.6 Corporate governance

In response to the current problems with the GEM board, the SEHK recently proposed
the strengthening of the corporate governance of GEM companies and requires at least
three Independent Non-Executive Directors (INED) on board. However, there is a study
that suggests little evidence of the relationship between a systematic governance structure
and financial performance (Dalton et al., 1998). The following hypothesis is used to
examine the value relevance of the participation rate of INED and the ratio between the
number of INED and the number of other directors on board:

H6a The higher the INED participation ratio (CG1), the stronger the value
sustainability (VS).
From prior studies on corporate governance, there have been confirmations about the
positive influence of institutional and corporate investors’ investments and board
participation, as well as the sharing of power in the board by an entrepreneurial firm, on
the performance of companies (Daily and Dalton, 1992; Filatotchev et al., 2005). The
following hypothesis is used to test such an influence among the GEM companies:

H-6b The participation of institutional or corporate investors (CG2) would have a

positive influence on value sustainability (VS).

4 Data collection and analysis

4.1 Data collection
This study has reviewed and collected the relevant data and information from the
prospectuses of the GEM companies listed in the stock exchange from 1999, the
commencing year of the GEM board, to 2004. During these five consecutive years, there
were 214 companies listed on the second board in Hong Kong. The prospectuses of these
companies were publicly available through the SEHK. These GEM companies are largely
young enterprises from various emerging new technology-driven industries, including
mostly internet and IT-related, software development, manufacturing, pharmaceutical and
healthcare industries. About US$4.1 billion was raised during the prescribed period
through the GEM exchange.

4.2 Data analysis

To further explore the significance of the independent variables in influencing value
sustainability, a multiple regression model that attempts to examine the factors that
influence the value sustainability of the GEM companies is developed. Initially, the
independent variables in the previous hypotheses are included in the simulation model,
as follows:
VSi = α + β1 YBi + β2 NIGi + β3 NI / MCi + β4 log CRi + β5 log MCi + β6 IA1i / MCi
+ β7 IA2i / MCi + β8 IA3i + β9 HC1i + β10 HC2i + β11CG1i + β12 CG2i + εi ,
 The value relevance of human capital 443

where:
VS = value sustainability of GEM company i,
α = constant
β1–12 = coefficient of variables
YB = years in business for GEM company i
NIG = net income growth prior to IPO for GEM company i
CR = capital raised in IPO by GEM company i
MC = market capitalisation at IPO by GEM company i
IA1 = amount of prior R&D expenditures by GEM company i
IA2 = amount of capitalised intangible assets by GEM company i
IA3 = extensiveness of combined disclosures on intangible assets by
GEM company i
HC1 = total years of work experience among the key management in
GEM company i
HC2 = existence of a stock option programme for management in GEM company i
CG1 = participation ratio between INED and other directors in the board within
GEM company i
CG2 = existence of institutional or corporate investors in GEM company i
εi = error term.

5 Results

Out of the population of the 214 GEM companies listed in the stock exchange for the
period from 1990 to 2004, 71 of them are determined as usable data after the exclusion of
a number of ‘delisted’ and restructured companies, as well as certain GEM companies
which demonstrate a highly irregular market pricing during the prescribed period. Only
31.6% of the GEM companies were able to maintain a VS equal to or greater than one a
year after the launch of IPO. Table 1 provides a selected summary of the descriptive
statistics of the key variables.

Table 1 The statistical summary of the key variables

Financial measures
Results VS YB NIG NI/MC NI MC CR
Units Ratio Years Ratio Years (’000) (’000) (’000)
Average 0.8554 2.1111 –79.57% 0.0713 $7,906 $732,697 $152,574
Intangible assets
Results IA1 IA2 IA3 HC1 HC2 CG1 CG2
Units (’000) (’000) (0–3) Years (1 or 0) Ratio (’000)
Average 2691 3487 1.243 267 n/a 0.490 n/a
% of count 40.35% 37.43% n/a n/a 76.61% n/a 45.03%
444 A.W. Ng

Second, the correlation analysis table is provided in Table 2. Given the results, a
significant multicollinear relationship is not apparent among the independent
variables, except for the association between MC and CR.12 With respect to the
relationship between the dependent variables, it demonstrates that the independent
variables that singularly show most correlation with VS are IA3, CG2, GNI and NI/MC,
in descending order, while supporting the respective hypotheses. The factor of the
number of years of prior work experience among the key management (HC1) is noted to
be positively related to VS. In order to further investigate the existence of an optimisation
of such an independent variable, log (HC1) is added to the following multiple
regression analysis.
Subsequently, a multiple regression model analysis is conducted to explore the
underlying relationship further. The initial results are provided in Table 3, suggesting that
the model is able to explain 45.20% of the distribution of VS among the GEM
companies. In this initial summary, it shows that YB, GNI and NI/MC, the relatively
traditional financial measures, as well as the indicators for the size of the company in
terms of market capitalisation and the capital amount raised, have become rather
irrelevant with respect to VS. The independent variables of intangible assets (IA3) and
corporate governance (CG2) stand out to be the two variables with the highest t-values.
For human capital (HC1), its normal logarithm has produced a coefficient of the opposite
sign to the original variable, suggesting the possibility of an optimal level of work
experience among the key management.
In order to explore the underlying relationships among the companies during
the period of listing on GEM, further multiple regression analyses are conducted
through the batches of GEM companies that are listed in the five consecutive periods
of 1999–2000, 2001, 2002, 2003 and 2004, respectively. The key statistical results
are summarised in Table 4. According to the multiple regression analyses, IA3 (the
extensiveness of the disclosures on intangible assets) demonstrates its significance in four
out of the five prescribed periods. The participation of institutional or corporate investors
(CG2) also demonstrates its significant influence on the VS values of the GEM
companies in four periods. IA2/MC appears to be a significant determinant for the period
between 2001 and 2002, but changes its direction of influence in the two following
years.13 Table 4 provides a summary of the results of the multiple regression analyses for
the five prescribed periods.
The multiple regression analysis that was run for the period of 1999–2000 produces
the highest R-square, 0.8948, among the three scenarios. Both CG2 and IA3 are
demonstrated to be significant determinants. The scenario for the GEM companies listed
in 2001 generates an R-square of 0.7907, with IA2/MC replacing IA3 as the second
significant determinant for VS. However, the result deteriorates further in the next
prescribed period of 2002 in terms of the calculated R-square, suggesting that the lower
number of companies can be explained by the regression model. The results,
nevertheless, improve in the more recent two periods to the 0.70 level of computed
R-square, with the particular reemergence of the significance of HC1 and log HC1
suggesting the growing importance of optimal human capital. Unexpectedly, the capital
amount raised (CR) has emerged to become a significant independent variable to
positively influence VS.
 VS YB GNI NI/MC logCR logMC IA1/MC IA2/MC IA3 HC1 HC2 CG1 CG2
Table 2
VS 1.00000

YB 0.03817 1.00000

NIG 0.12438 0.04829 1.00000

NI/MC 0.10718 0.07751 0.09585 1.00000

The correlation matrix

logCR –0.08425 0.04266 –0.04903 –0.04880 1.00000

logMC –0.18952 –0.04770 –0.09402 –0.43159 0.78642 1.00000

The value relevance of human capital

IA1/MC 0.08180 0.17309 0.03367 0.07005 –0.00501 –0.16449 1.00000

IA2/MC 0.01356 0.00061 0.03813 0.30721 –0.07603 –0.23182 –0.00017 1.00000

IA3 0.57506 0.08830 0.25364 0.14134 –0.09277 –0.27199 0.19579 0.26790 1.00000

HC1 0.09585 0.08225 0.02219 0.28107 0.20681 0.02013 0.15128 –0.02181 0.01608 1.00000

HC2 –0.03746 0.01179 0.11674 –0.42459 –0.14062 0.17765 –0.18168 –0.04118 0.03125 –0.25402 1.00000

CG1 –0.06195 0.10482 0.01051 0.09219 –0.19878 –0.13001 –0.00096 –0.10602 –0.08411 –0.00367 0.07674 1.00000

CG2 0.48665 0.07531 0.11083 –0.03882 0.05490 –0.00835 0.10052 0.01093 0.42673 –0.02523 0.15086 –0.18014 1.00000
445
446 A.W. Ng

Table 3 The multiple regression results (n = 171)

Variables Coefficient Std. Err. t-value p-value

Regression coefficients
Constant 1.8576 1.1189 1.6602 0.0989
YB –0.0277 0.1338 –0.2067 0.8365
NIG –0.0009 0.0021 –0.4137 0.6797
NI/MC 0.4606 0.6779 0.6795 0.4979
logCR –0.2330 0.2634 –0.8846 0.3777
logMC 0.0837 0.2454 0.3409 0.7336
IA1/MC –0.8009 0.8439 –0.9490 0.3441
IA2/MC –1.9536 0.9770 –1.9997 0.0473
IA3 0.4793 0.0723 6.6291 0.0000
HC1 0.0003 0.0001 1.9235 0.0562
HC2 –0.2048 0.1426 –1.4361 0.1530
CG1 –0.0090 0.2331 –0.0387 0.9692
CG2 0.5210 0.1140 4.5687 0.0000
Log HC1 –0.2475 0.1975 –1.2532 0.2120
Summary measures
R-square 0.4520
Std. Err. of Est. 0.6417

Table 4 The summary of the multiple regression results from five consecutive time periods

Significant
Computed Original independent
Periods R-square R-square variables t-value Coefficient
1999–2000 0.8948 0.4520 CG2 7.7676 0.7307
IA3 3.5455 0.2306
log MC –2.4710 –0.4647
NI/MC –1.4325 –1.6525
2001 0.7907 0.4520 CG2 2.5278 0.6401
IA2/MC 1.7911 6.8155
log CR 1.5242 0.6363
HC2 –1.5080 0.8505
NI/MC –1.6055 –3.4277
2002 0.4887 0.4520 IA3 5.2441 0.9575
CG2 1.9489 0.5143
IA2/MC –1.6907 –6.3632
IA1/MC –1.3855 7.4537
 The value relevance of human capital 447

Table 4 The summary of the multiple regression results from five consecutive time
periods (continued)

Significant
Computed Original independent
Periods R-square R-square variables t-value Coefficient
2003 0.7048 0.4520 CG2 1.4751 0.6179
IA2/MC –1.1727 –2.5676
IA3 1.1197 0.4278
NI/MC 1.1092 2.149
HC1 1.0418 0.0003
log HC1 –1.1251 –0.4622
2004 0.7051 0.4520 log CR 1.4654 5.3182
HC2 1.3848 2.5374
HC1 1.2300 0.0003
IA3 1.0278 0.2190
log MC –1.6248 –5.5098
IA2/MC –1.4637 –4.3662
log HC1 –1.1916 –0.4367

6 Discussion

Through the sequence of multiple regression analyses, the quantitative analysis conveys
the significance of two independent variables of intangible assets – the value intensity
for R&D expenditures (IA1/MC) and capitalised intangible assets (IA2/MC) – as
determinants of VS. The extensiveness of the disclosures on intangible assets (IA3) is
found to be the most consistent and significant independent variable among the others
under the statistical analyses. On the other hand, the results show that both IA1 and IA2
have changed their directions of influence among the GEM companies in the more recent
periods. In fact, such a change in relationships might be caused by attempts in earnings
management, as suggested by prior studies about the potential manipulation of the
accounting treatments of intangible assets (Lev et al., 2005; Mohd, 2005).
While the evidence of this research is based on the disclosures in the IPO
prospectuses of growth enterprises in Hong Kong, the results demonstrate similarity in
the criticalness of R&D resources and capitalised intangible assets with respect to
value relevance, as concluded in prior international studies, namely Lev and Sougiannis
(1996), as well as Han and Manry (2004). More importantly, particular results of this
research echo the value relevance in certain nonfinancial information, for instance, as
demonstrated by the significance of the extensiveness of the combined recognition of and
disclosures on intangible assets (IA3).
The nonfinancial information of human capital appears to be relatively less
significant than the reported intangible assets in directly generating VS. Nevertheless, the
number of years of work experience among the key management (HC1), as developed in
the subsequent multiple regressions, suggests an optimal level to influence VS. This
particular finding is consistent with the notion of the average age among the founding
448 A.W. Ng

managers, as studied by Honig (2001). Furthering on human capital, it, however, unveils
that the stock option (HC2) does not hold up as a consistent factor that would sustain
value among the GEM companies.
On corporate governance among the GEM companies, there is strong evidence of
the participation of institutional and/or corporate investors (CG2) in determining VS.
This particular phenomenon corresponds to the prior studies on corporate governance
among the listed companies in Taiwan (Filatotchev et al., 2005) and the notion of power
sharing in a board among entrepreneurial firms (Daily and Dalton, 1992). However, it is
observed that no evidence suggests a positive influence of the number of INED on the
board on VS.

7 Conclusions

There is no exception in the case of Hong Kong for the growing importance of
recognising intangible assets as value-relevant factors. Traditional measures and financial
indicators, such as the prior years in business and the historical financial performance,
can no longer explain the value relevance of the growing knowledge-intensive
enterprises. While accounting standards on intangible assets have been introduced in
recent years for Hong Kong to harmonise with IAS,14 the depth and extensiveness of
voluntary disclosures on the intangible qualities of the GEM companies have, however,
appeared to be insufficient and unstructured, particularly in nonfinancial information.
Given the demonstrated importance of reporting intangible qualities, an integrated
framework to disclose the range of value-relevant financial and nonfinancial indicators
can be useful to potential investors in assessing the future prospects of a GEM listing
candidate. However, the stakeholders ought to be cautious of potentially irregular
behaviour in overstating the capitalised intangible assets, misclassifying R&D
expenditures and embellishing the intangible qualities when there is a perceived value
relevance of intangible assets.
To enhance the reporting of the intangibles, an intellectual capital framework
can be constructed to provide the disclosures of relevant information about human capital
and corporate governance in place. This integrated approach would potentially mitigate
the information asymmetry that is associated with investing in growth enterprises, which
are complicated by disruptive changes that are related to emerging technological
innovations and the internal characteristics within an entrepreneurial firm. The results of
this study hold the view that the disclosures of intellectual capital would provide relevant
and timely information to decision-makers, as suggested by Roos et al. (2005). Such
a framework, however, would require taking into consideration the cultural factor
embedded in an organisation that may inhibit or stimulate the development of intangible
assets and other intangible factors. In the context of Chinese culture, it would be useful to
explore in future studies the influence of a homogeneous, family-centric governance
culture over an emphasis on the development of intangible qualities and on the reporting
of intangible assets. Lastly, it would be beneficial for equity stakeholders to understand
how institutional and corporate investors would ‘neutralise’ such a habitual culture within
a corporate setting and bring value to growth enterprises.
 The value relevance of human capital 449

For the regulator of the GEM board, it implies the importance of enforcing relevant
and detailed disclosures on intangible qualities in the prospectus, among others. In
particular, the emphasis on detailing the nonfinancial information aspects of intangible
assets is critical. The compliance with the new accounting standards on intangible assets
should demand detailed explanations on their implications on future economic benefits,
an important criterion of the standard, rather than giving simple explanations of the
nature of the intangible assets and the related financial figures as the predominant
disclosures in most of the prospectuses. In other words, it presents the opportunity to
improve the integration between the reporting of financial and nonfinancial information
about the intangible qualities of an IPO candidate. With respect to the disclosures and
requirements on INED, it appears that there is no value relevance of the participation rate,
but the involvement of a strategic investor on the board and the quality of its participation
could be more important to sustaining a GEM company’s value. All in all, rather than
pinpointing a statutory compliance and disclosure requirement, the regulator may ask for
a comprehensive disclosure of the complementary intangible qualities that would enhance
the usefulness and integrity of the disclosures to investors. As one fund manager candidly
expressed, “Their fundamentals are so poor that nothing can be done to attract investors,
even if they improve their disclosure on corporate governance issues.”15

Acknowledgement

I would like to thank Mr. Tan Yean Pau, a Chartered Financial Analyst, for giving me
useful comments on an earlier draft of this article.

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Notes
1 These studies include the research performed by Jaggi (1997) and Chan et al. (1996)
regarding the accuracy of the forecast information disclosed in the IPO prospectuses of
Hong Kong companies.
2 These studies include the research on science and technology firms in the USA by Deng et al.
(1999), as well as the investigation of Korean firms by Han and Manry (2004).
3 A summary of such literature on intellectual capital is provided in Section 2.
4 See Section 2.3.
5 Mr. Charles Lee, the Chairman of the Hong Kong Exchanges and Clearing Committee,
expressed, “There may be some failures on the GEM, but it is the characteristic of the second
board as it is a market for newly established companies so it has a high ratio of failures”
(Yiu, 2005).
6 According to the HKICPA, the companies listed on the GEM board barely meet the disclosure
standards of the stock exchange (Lee, 2005).
7 The companies listed on the Main Board tend to provide profit forecasts in their prospectuses,
as pointed out by Chan et al. (1996) and Jaggi (1997). The determinants for the accuracy of
the forecasts are explored in these studies.
8 It refers to Section 2.2 and its discussion about the recent research on the topic of
intellectual capital.
9 Measured as R&D expenditures (IA1) divided by market capitalisation (MC).
452 A.W. Ng

10 Measured as capitalised intangible assets (IA2) divided by market capitalisation (MC).

11 A scale of 0–3 is adopted for the measurement of IA3, where one point is given respectively
for the presence of each of the following items: (1) the recognition and disclosure of
R&D expenditures, (2) the recognition and disclosure of capitalised intangible assets and
(3) detailed discussion and analysis on the use of intangible assets that would benefit the
future prospects.
12 Both variables remained in the subsequent multiple regression analysis for further tests of the
underlying relationships and interactions with the other independent variables
13 In fact, Han and Manry (2004) found similar reversing results on R&D expenditures as a
factor in the value relevance among the Korean companies through yearly regressions. The
change of IA1/MC and IA2/MC from a positive to a negative coefficient in 2002 suggests
the deterioration of the effectiveness of the resources allocated in R&D and intangible assets
in sustaining the values of the GEM companies. Furthermore, IA2/MC obtains a negative
coefficient with an absolute t-value that is greater than that in both 2003 and 2004. This
particular observation of change goes across the point in time when the new accounting
standard on intangible assets was adopted in early 2001, implying its possible influence over
the reported amounts of IA1/MC and IA2/MC.
14 It is important to note that the HKICPA only released SSAP 29 on Intangible Assets in
January 2001 to complement any deficiency in their existing standards. Subsequently, in
August 2004, the HKICPA released HKAS 38 to replace SSAP in order to make further
clarifications on the standards for intangible assets and to harmonise with IAS 38.
15 The Standard, ‘GEM firms barely pass standards’, 30 November 2005.
 The value relevance of human capital 453

Appendix
Principal GEM Board Listing Requirements
The information set out below is a summary of the listing requirements extracted from
the Rules Governing the Listing of Securities on the Growth Enterprise Market (the
‘GEM Listing Rules’).1

No profit requirement
In recognition that promising growth enterprises may not always have achieved a
past profit record, the GEM Listing Rules does not impose a profit requirement on
listing applicants.

Sponsor and sponsorship period

A listing applicant must appoint a GEM Sponsor to submit its listing application and the
appointment must continue for a fixed period, covering at least the period comprising the
remainder of the financial year in which listing takes place and the two full financial
years thereafter (the ‘Period’).

Acceptable jurisdictions
The new applicant must be incorporated under the laws of Hong Kong, the PRC,
Bermuda or the Cayman Islands.

Operating history
The new applicant must:
1 demonstrate at least 24 months of Active Business Pursuits immediately preceding
the date of submission of the listing application. Such a requirement can be reduced
to 12 months if:
• the company has a total turnover of not less than HK$500 million in the last
12-month period, as reported in the accountants’ report contained in the initial
listing document, total assets of not less than HK$500 million, as shown in the
balance sheet in respect of the last financial period reported upon in the
accountants’ report, or market capitalisation of at least HK$500 million
determined at the time of listing
• at the time of listing, the company has a minimum market capitalisation of
HK$150 million in public hands, which is held by at least 300 shareholders,
with the largest 5 and largest 25 of such shareholders holding in aggregate not
more than 35% and 50%, respectively, of the equity securities in public hands
• the initial public offer price of the shares is not less than HK$1.
Note: In the case of a newly formed project company, natural resource exploitation
company, or in exceptional circumstances acceptable to the Exchange, this
requirement of 24 months of Active Business Pursuits may be relaxed subject to the
Exchange’s approval.
454 A.W. Ng

2 have actively pursued a focused line of business

3 be under substantially the same management and ownership over the period of
Active Business Pursuits
4 control the board of the subsidiary or subsidiaries and have an effective economic
interest of not less than 50% of that subsidiary or those subsidiaries, if the active
business is carried out by its subsidiary or subsidiaries
5 have an accountants’ report covering at least two full financial years immediately
prior to the date of listing document or if the new applicant satisfied the conditions
set out in items (1)(a) to (c), covering at least the 12-month period from the
commencement of its Active Business Pursuits.

Future prospects
The new applicant must set out its business objectives and explain how it proposes to
achieve them over the Period.

Note
1 www.hkgem.com