AEA papers on valuing intangibles

Follow on yesterday's posting, this year's AEA/ASSA meeting in Atlanta had two interesting papers on valuing intangibles:

Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices
Alex Edmans (University of Pennsylvania)
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Financial Value of Reputation: Evidence from the eBay Auctions of Gmail Invitations
Qin Lei (Southern Methodist University)
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Edman looked at the stock performance of the Fortune "100 Best Companies to Work For." Not only did these companies do better in the stock market, they had "significantly more positive earnings surprises and stock price reactions to earnings announcement." His conclusions are interesting in what they imply for both managers' and investors' behavior:

This paper finds that firms with high levels of employee satisfaction generate superior long-horizon returns, even when controlling for industries, factor risk or a broad set of observable characteristics. These findings imply that the market fails to incorporate intangible assets fully into stock valuations - even if the existence of such assets is verified by a widely respected and highly publicized survey on large companies. This suggests that the non-incorporation of intangibles, documented by prior studies, is not simply due to the lack of salient information on them. It also provides empirical support for theoretical models of managerial myopia, which require the assumption that long-run investment is not incorporated into investors' assessments of firm value. Even if managers are able to credibly communicate the value of their intangible investment, it may still not affect outsiders' valuations, and so they may be reluctant to invest in the first place.

In other words, it is not simply a question of information. The Best Companies list has been around for years, but investors don't seem to incorporate it into their decision process. As he states, "investors use traditional valuation methodologies, devised for the 20th century firm and based on physical assets, which cannot incorporate intangibles easily even if they are known."

Of course, this all assumes that the stock market is the great leveler - if all information is incorporated then there would not be superior stockholder returns.

By the way, the paper has a good discussion on the theory of the importance of human capital and on the value of "socially responsible investing" (SRI). It also has a smaller discussion on the non-incorporation of intangibles in financial reports.


The Lei paper looks at the theoretical proposition that reputation is a signal for quality and should therefore command a price premium. The findings are not surprising, but conclusive:

Sellers who improve both measures of reputation from the lowest to the next quintile experience a 6.2% higher probability of sale and a 6.1% hike in the implied buyer's valuation.

And, as Lei points out, this test was based on a rather simple market transaction. For a more complex transaction, one can safely assume that reputation is even more important.