Rethink issues of productivity, income inequality and industry concentration
In 1975, intangible assets made up just 17% of the assets on the balance sheets of S&P 500 companies. The category was largely ignored and seen as a grab bag of goodwill left over from accounting for mergers, patents and other intellectual property. The category was a bit suspect. In fact, the term tangible book value (the net value of tangible assets, fixed assets and inventory, etc.) has been popularized as a sign of corporate strength, which in the case of intangible assets implies the opposite.
Less than 50 years later, intangible assets exceed 90% of total assets. This is due to the dominance of software in the economy and technology companies becoming the most heavily weighted sector in the S&P 500 by market cap.
A working paper by Northwestern’s Nicolas Crouzet and Janice C. Eberly, UCLA Anderson’s Andrea L. Eisfeldt, and Northwestern’s Dimitris Papanikolaou suggests that many changes in the economy over this 50-year period could be better understood if we looked at a better Characteristics of intangible assets and how they affect companies would have an understanding of this.
Researchers examined how intangibles may help explain recent macro trends in the economy:
inequality of income and wealth
When intangible assets become an important part of a company’s total assets, employees with the skills to work with these assets are in high demand. This can lead to increased income inequality between these workers and other workers whose more traditional skills are tied to physical assets.
Inequality is also increasing as the benefits of innovation are not widely shared. Entrepreneurs benefit the most.
Intangible assets may help explain the decline in investment in physical capital in recent years, even as returns on physical assets appear to be increasing. It sounds strange that investment in property, plant and equipment should decline when the income from its operation increases. The researchers suspect that this is due to an incorrect measurement. The numerator of the return measurement captures the market value of the entire business (including the benefits of intangible capital), while the denominator includes only tangible assets.
Technological advances in storing intangible assets—think how software today resides in the cloud, is powered by its maker, and is used by millions of customers simultaneously—has led to a rapid rise in intangible assets over the past few decades. Lack of inventory means investment in intangibles is held back.
Increasing market power
An intangible asset, such as software or a patent, that is used concurrently by multiple units of a firm and is protected from imitation by patents or other means is likely to generate returns in excess of its marginal cost because it creates economies of scale for the firm. This advantage can result in the company capturing a large percentage of its market and creating a situation akin to a natural monopoly – a market in which one major player has a cost advantage over competitors.
The researchers suggest that the recent slowdown in productivity growth may be partly due to current measurement methodology failing to capture the positive spillover effect of intangibles, and that losses from spillover effects can weigh on growth. Co-benefits here mean that the benefits of the intangible asset accrue not only to the company that owns the asset, but also to other companies and individuals in the economy. An example of a positive spillover is an intangible asset — say, software or a patent on a drug — that fuels the development of an even better idea at a competing company. In this way, intangible assets can indirectly increase the productivity of other companies, but also discourage investment in spillover intangibles.
An intangible asset must be stored in order to be funded and to allocate ownership of its future cash flows. The cost of leverage increases when the type of storage makes it difficult to use as collateral. For example, intangibles stored in key talent or certain technical advances in the company are difficult for investors to value, while intangibles stored in software can be pledged to external investors. Because of this, companies with significant intangible assets receive more funding from their own employees and founders than companies with fewer intangible assets.
Crouzet, Eberly, Eisfeldt, and Papanikolaou hope that future research in this area will increase as the focus becomes more on the properties of intangible assets and the economic implications of those properties.
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