The market-to-book value gap and the accounting fallacy
| DOI | https://doi.org/10.1108/JIC-10-2012-0094 |
| Pages | 564-581 |
| Date | 21 October 2013 |
| Published date | 21 October 2013 |
| Author | Giuseppe Marzo |
| Subject Matter | Information & knowledge management,Knowledge management |
The market-to-book value gap
and the accounting fallacy
Giuseppe Marzo
Department of Economics and Management,
University of Ferrara, Ferrara, Italy
Abstract
Purpose – The purpose of the paper is to offer some advancing in the understanding of the
market-to-book value (MBV) gap (or ratio) as the symptom a nd the metrics for intellectual
capital (IC) value, and to discuss the major criticisms against it. The original contribution
of the paper lies in developing the analysis of the meaning o f the MBV from a theory-of-the-
firm perspective. Such an approach is employed to shed light on the two sides of MBV: book and
market values.
Design/methodology/approach – The paper reviews research on MBV and the theory of the firm,
employing a deductive approach that explores criticisms and advantages of the use of the MBV gap as
the symptom and the metrics of IC according to a specific theory of the firm.
Findings – The paper finds that the presumption that an “accounting fallacy” exists, which refers
to the gap between market and book values, must be revised depending on the chosen theory of the
firm. In fact, depending on the theory of the firm to which IC scholars refer, book value could not
necessarily equate to market value, even if the latter was unbiased. Again, market value could not be
able to express the value of IC.
Research limitations/implications – Implications of the p aper are mainly fo r improving
consistency in research, but they also support practice for consciousness and awareness.
Limitations are the following. First, the paper offers an analysis of just three selected theories
of the firm. Second, the analysis is based on a deductive reasoning that can be criticised for
results even if not for the aim. Third, one c ould feel that an IC -centred theory of th e firm does not
yet exist at all.
Practical implications – Once reasons for abandoning the misbelief that accounting standards
should be set in order to close the gap are highlighted, research on IC can move towards more
appropriate goals. On the basis of the criticism presented in the paper, empirical research, which
makes use of market and book data, could be carried out in a much more consistent way in relation
to theoretical background. The paper highlights how the use of the MBV approach can lead to
mistakes without a clear reference to the theory of the firm.
Originality/value – The paper focuses on the meaning of the MBV from a theory-of-the-firm
perspective, assisting the researcher in avoiding potential mistakes and inconsistencies in their work,
and also suggesting some consequences on the practice of IC.
Keywords Intellectual capital, Behavioural finance, Market-to-book gap, Theory of the firm
Paper type Conceptual paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1469-1930.htm
Received 20 October 2012
Revised 27 January 2013
5 February 2013
Accepted 6 February 2013
Journal of Intellectual Capital
Vol. 14 No. 4, 2013
pp. 564-581
rEmeraldGroup PublishingLimited
1469-1930
DOI 10.1108/JIC-10-2012-0094
Some of the ideas presented in the paper have been discussed at The 6th Interdisciplinary
Workshop on Intangibles, Intellectual Capital & Extra-Financial Information, Catania, Italy,
30 September-1 October 2010; at The 34th Annual Congress of the European Accounting
Association, Rome , Italy, 20-22 April 2011; at The Roma I II University Workshop on
Intangibles, Rome , Italy, 12 April 2011; at the “Innovation in network industries: accounting,
economic and regulatory implications” Seminar, Paris, France, 16 March 2011; and at
The SASE 23rd Annual Conference, Madrid, 23-25 June 2011. The author thanks participants
to the meetings for their helpful insights. The author also acknowledges useful comments
by two anonymous refe rees. As usual, all rem aining errors a nd obscurities a re the author’s
responsibility.
564
JIC
14,4
1. Introduction
Market-to-book value (MBV) and intellectual capital (IC) are usually considered as two
congenial twins, since the former is seen to be at the same time both a symptom of
and the metrics for the latter.
Since the 1960s (Galbraith, 1967) to more recent times (Bontis, 1996; Stewart, 1997;
Sveiby,1997, 2010; Edvinsson and Malone, 1997; Andriessen, 2004) IC has been defined
as the difference of an organisation’s market value and book value. Whilst this is not
necessarily a unique or shared view among researchers on IC, such a perspective is
doubtless very common in the field. As Dumay (2012) notes, the MBV gap (or ratio)
is in fact one of the two grand theories on IC.
Considering MBV and IC as the two sides of the same coin has certainly pushed the
interest in IC at the end of last century, when researchers reported MBV ratios larger
than one. The average MBV ratio for the companies of the S&P 500 index ranged
in fact from around 2.0 to 3.5 in the period 1990-1995, and from 3.5 to 7.5 during the
“tech boom” period 1996-2000 (Lev, 2001). The large MBV gap leads to criticisms
against accounting, blamed for the inability to take into account the IC value. For IC
accountants, “mind the gap” has been the mantra for about 20 years of research on IC.
Things changed at the beginning of 2000, when market values started falling.
The average MBV ratio fell on the US market at about 2.0 at the beginning of this year
(Damodaran, 2012). IC researchers, who refer to the MBV gap as the value of IC,
probably struggled at the time MBV started fall, as IC value decreased dramatically.
IC accountants devoted much of their efforts in an attempt to modify accounting
standards, in order to put the IC value on the balance sheet and c lose that gap, and
were struck when the gap started closing from the wrong side, i.e. the market value.
While a large number of IC scholars aim at closing the MBV gap. Different positions
also exist, some of which are summarised in Section 2.
This paper, however, takes a different and multidisciplinary (Marr, 2005;
Chaminade and Catasu
´s, 2007) perspective, as it is based on the premise that the
meaning of MBV, and therefore the problem of accounting fallacy (i.e. if book value
should converge to market value), strongly depends on the particular theory of the firm
adopted by researcher. Depending on the espoused theory of the firm, in fact, the MBV
gap could be a weakness of accounting or inste ad its strength.
Section 3 will present three selected theories of the firm, and Section 4 will discuss
their implications as to the meaning of MBV and for its employ in empirical research,
highlighting the role of each theory of the firm in regard to the meaning of MBV.
The paper of course focuses on the external financial reporting aspect of MBV.
2. The MBV approach to IC
Studying MBV as the mirror of IC should be carefully analysed, in relation to both the
basic assumptions it is based upon and for its implications, herewith including
also some counter-intuitive considerations to which it can lead. The basic assumption
is that market value, and not accounting value, is the reference point to be adopted.
We live in a market economy, and all we say, referring to market as a reference
point for our economic decisions, is probably a natural consequ ence of it. The problem
really comes in when the market in which we live is different from the theorised one.
Capital market is in fact idealised as the Eden or Nirvana. This is a legacy from
neoclassical economics which also entered finance theory at the end of the 1950s and
progressively other disciplines such as probably accounting. For finance scholars
(capital) market prices incorporate in an efficient way all the available information
565
Market-to-book
value gap
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