Current Issues, Recent Advancements, and Future Directions,

ERIC G. FLAMHOLTZ, UNIVERSITY OF CALIFORNIA LOS ANGELES ANDERSON GRADUATE SCHOOL OF MANAGEMENT AND ERICA D. MAIN, TRILOGY ASSOCIATES, INC.* ABSTRACT a significant transformation in the world economy and the organisations that comprise it. The economy of old was manufacturingbased and relied heavily on tangible assets as determinants of value. In contrast, the present-day economy is based on knowledge and information, intangible assets that are embodied in people. This shift has triggered the development of tools with which to measure these intangible assets. One accounting tool that is directly relevant to the measurement and, in turn, the management of human capital is human resource accounting. The purpose of this article is to discuss some current issues, recent advancements, and possible future directions for further development. THE TRANSFORMING ECONOMY
There is growing recognition that over the past few decades most of the world's advanced economies have made a gradual yet fundamental transformation. They have shifted from industrial economies in which plant and equipment are the core assets to post-industrial economies in which intellectual property, specifically human capital, is the core asset. This transformation is evident not only in the economy as a whole, but in the very organisations of which it is comprised. The shifting fortunes of specific organisations are concrete manifestations of the general and broad trend toward a human capital intensive economy. While most firms in the industrial era, by definition, relied on manufacturing capabilities, companies in the post-industrial era now rely almost completely on knowledge and information for survival and profit. While long dominant companies such as U.S. Steel, General Motors, and International Harvester have gone into decline, modern companies such as Microsoft, Intel Corp., and Amgen have emerged as the hallmark of the new era. In this era, the potential success of an organisation lies in its intellectual capabilities rather than in its physical assets. Accordingly, organisations must pay particular attention to the development and deployment of human and intellectual capital. Unfortunately, neither financial nor managerial accounting has responded to this change in circumstances. Furthermore, the accounting paradigm and related measurement technology have not been re-conceptualised to account for this economic transformation. Due to the continued use of measurement tools that are no longer well suited to the current era, anomalies have resulted. For example, one tool that was initially designed by financial theorists to indicate whether the value of the stock market is fair and accurate is "Tobin's q," developed
*Note: A version of this manuscript will also appear as chapter 14 in Eric G. Flamholtz, Human Resource Accounting, Kluwer Academic Publishers, 1999 (forthcoming).
JOURNAL OF HUMAN RESOURCE COSTING AND ACCOUNTING • VOLUME 4 • NUMBER 1 • SPRING 1999 • PAGES 11-20
Current Issues, Recent Advancements, and Future Directions in Human Resource Accounting
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CURRENT ISSUES AND FUTURE DIRECTIONS OF HRA
by Yale scholar and Nobel Prize Laureate James Tobin (Lindberg & Ross, 1981). TOBIN'S Q AND RELATED MEASUREMENTS Tobin developed a theory of investment behavior, which is based on the assumption that firms will continue to invest as long as the value of their market shares exceeds the entire replacement cost of the actual, physical assets of the firm. To measure this notion, Tobin developed a construct known as the "q ratio" or "Tobin's q," which is essentially the ratio of two numbers. The first number is the actual value of the firm to its shareholders or investors, or the expected future profits of the firm. This is typically measured in terms of actual market capitalisation. The second number in the ratio represents the total replacement cost of the assets of the firm, including the plant, the equipment, the machines, the buildings, and related assets. These two numbers are compared in order to assist in making strategic decisions for a firm. If the first number in the ratio exceeds the second (in which case q would be greater than one), the firm should logically desire expansion. This is because the expected profits resulting from the assets outweigh the total cost of the assets. In contrast, if the second figure in the ratio is larger than the first (in which case q would be less than one), the shares of the firm are worth less than the assets themselves, and the firm will benefit by engaging in divestment. Divestment takes place when the assets are sold rather than utilised. Tobin's q suggests that firms will invest or divest incrementally until q is approximately equal to one. In brief, Tobin argued that one of the primary factors that determines whether or not there will be investment in a firm is not the interest rate, but rather the price of shares in the stock market relative to the total value of its machinery and other assets. Thus, when Tobin's q is high (as in a stock market boom), investment is high and the corresponding market value of thefirmis high. This measure has also been used by economic and financial analysts to determine whether the stock market as a whole is overvalued or undervalued. In fact, some stock market strategists cited the extremely high q ratio as support of the judgement that the U.S. stock market was overvalued in 1994, prior to the continued appreciation in share prices in 1995, 96, 97 and 98. The problem is that the ratio was derived from an industrial era paradigm, in which human capital and intellectual property did not play such a critical role. Accordingly, while Tobin's q was giving a false signal of overvaluation, the stock prices of companies like Intel, Microsoft, Amgen and many others were appreciating. To illustrate the distortions caused when measurements like Tobin's q are used, the following two tables contrast two types of organisations: (1) "classic" manufacturing-based companies, which rely on physical assets such as buildings, equipment, and inventories as their core economic assets, and (2) "modern" knowledge-intensive organisations, which rely on human capital and intellectual property as their core economic assets.