From where we sit, the new era economy should continue to defy the outmoded actuarial tables that attempt to quantify it. On this score, recent work by Baruch Lev has been truly eye-opening. Lev is, among other things, the Philip Bardes Professor of Accounting and Finance at NYU's Leonard N. Stern's School of Business, as well as the director of the Vincent C. Ross Institute of Accounting Research and the Project for Research on Intangibles. He has pioneered the development of a Knowledge Capital Scoreboard, which attempts to put hard numbers to intangible assets. Fed Chairman Alan Greenspan recently noted that during the second half of the twentieth century, the US tripled the real value of its output with no increase in the weight of the materials produced.
Lev contends that the half-a-millennium-old accounting standards developed by an Italian monk in the 15th Century form a hopelessly antiquated approach to determining value in the marketplace. Luca Pacioli's system is entirely based on transactions. But transactions and tangible assets describe a constantly shrinking portion of today's economy. Economist John Kendrick has studied the main drivers of economic growth and reports that there has been a general increase in the contribution that intangible assets have made to US growth since the early 1900's. In 1929, for example, the ratio of intangible business capital to tangible business capital was 30% to 70%. In 1990 that ratio was 63% to 37%. So generally accepted accounting no longer delivers accountability.
Think about it. Lev points out that when a drug passes its clinical test, huge value is created but there's no transaction. Nothing changes hands. Nobody buys anything and nobody sells anything. When software passes a beta-test it suddenly becomes valuable but, again, there's no transaction. Or think about how value is destroyed. When a big, old company is late in figuring out how to enter the world of e-commerce, huge value is destroyed but there is no transaction. This helps explain why - in the midst of a torrid 85% bull market gain in NASDAQ stocks last year - half of the stocks in the S&P 500 were down in 1999, and why more stocks made new lows than new highs by a wide margin.
Even more illustrative of the market's harsh treatment of companies that refuse to embrace change is one recent study that showed that stocks with no earnings had gained on average 52% while stocks with earnings had lost 2%. Grasping the significance of knowledge-based, or intangible, assets is what separates the sentient from the stillborn in today's financial arena. The analytical ground is just being broken on this front and promises to deliver an endless bounty of insight and opportunity to investors.