Intellectual capital and firm performance: Static or dynamic estimation: Evidence from the UK

Abstract

The existing literature on Intellectual Capital (IC) and firm performance has often ignored an important econometric aspect i.e. the presence of endogeneity. We apply a series of tests such as dynamic OLS and strict exogeneity test to prove that this relationship is dynamic in nature and the application of static estimators such as the traditional OLS and fixed-effects can potentially generate biased results. This study uses dynamic panel data estimation to overcome the problem of endogeneity in analysing the relationship between IC and financial performance of the firms. We use two-step system generalized methods of moments estimator which can incorporate this dynamic relationship to provide valid instruments in order to overcome unobserved heterogeneity and simultaneity issues. Our study includes 774 publically listed firms from the London Stock Exchange for the period of 2005 to 2014 to measure the relationship between IC efficiency (measured in terms of VAIC) and firm performance (in terms of ROA, ROE, ATO and P/B). Our results reveal that IC efficiency (VAIC) is positively and significantly related to firm performance particularly with ROA and weekly with ROE but insignificant with assets turnover and P/B ratio. We extend our analysis to individual components of VAIC i.e. human, structural and physical capital and find that structural capital and physical capital are significantly related with firm performance. Human capital is not significantly correlated with firm performance whereas this relationship is significant when we apply static OLS and fixed-effects in our study. The interaction terms of IC and financial crisis 2008 report that IC efficiency is generally unchanged during the financial turmoil. We also find that current IC efficiency is related with past firm performance up to three years which means that investments in IC resources take some time to payback. These findings are useful for policy makers who decide about investments in IC resources.