CHAPTER II

THEORITICAL FRAMEWORK AND HYPOTHESE FORMULATION

2.1

Previous Research Model

Ghanei and Kheibari (2015) investigate the relationship between stock

return and future growth rate and efficiency of intellectual capital. The sample
consisted of 137 companies listed on the Tehran Stock Exchange during the period
of four years from 2010 to 2013. This study examines the effect of intellectual
capital to prove that companies with a higher level of control and focus on their
intangible assets generate a better performance and higher return in stocks. The
dependent variables are stock returns and growth on sales. Intellectual capital,
firm size, and financial performance are used as the independent variables.
Figure 2.1
A Survey of the Relationship between Intellectual Capital and Firm Performance
Criteria Model
Intellectual Capital
Firm Size
Financial Performance

Stock Returns
Growth on Sales
Note:
Independent Variable
Control Variable

Source: Ghanei and Kheibari (2015).

Fallah and Deslam (2015) examine the effect of intellectual capital and its
components on the equity return of the firms listed in stock exchange. The study
period included three years before subsidy reform (2007-2010) and three years
after it (2011-2013). The study sample consisted of 81 firms listed on Tehran

Stock Exchange. The purpose of the study is to promote the importance of

intellectual capital as a competitive advantage in improving economy and
increasing productive investment. The dependent variable in this study is stock
return and the independent variables are intellectual capital efficiency, capital
employed efficiency, human capital efficiency, and structural capital efficiency.
Kermani et al (2014) study the influence of intellectual capital in the
shareholders expected return in 104 companies listed on Tehran stock exchange
during the period of 2007 to 2011. The dependent variable is expected returns by
shareholders and the independent variable is thought capital. Some of the control
variables used in this study due to their effect on the independent variables are
company size and leverage.
Figure 2.2
The Influence of Intellectual Capital on Shareholders Expected Return Model
Thought Capital
Company Size

Expected returns by the shareholders

Leverage
Note:
Independent Variable
Control Variable
Source: Kermani et al (2014).
Vakilifard and Rasouli (2013) examine the relationship between
intellectual capital, income smoothing, and stock returns. The sample includes 108
medical companies listed on Tehran Stock Exchange. The dependent variables are
income smoothing and stock returns. While the independent variables for this
study use value added intellectual capital (VAIC) from the Pulic model which

includes value added capital coefficient (VACA), value added structural capital
coefficient (VAST), and value added human capital coefficient (VAHU). This
study investigates whether the intellectual capital components can result in higher
value creation and more persistent earnings.
Figure 2.3
The Relationship between Intellectual Capital and Income Smoothing and Stock
Returns (Case in Medical Companies) Model
VAIC
VACA

Income Smoothing
Stock Returns

VAST
VAHU
Source: Vakilifard and Rasouli (2013).

Note:
Independent Variable
Control Variable

Lofti et al (2013) investigate the impact of intellectual capital on capital

gains of investors in the chemical industry in Tehran stock exchange. The study is
based on a survey of analyticaldescriptive method which in a functional form
studies the relationship between intellectual capital and capital gains, the investors
of the companies related to the chemical industry during 2004-2011. The
independent variables are the model of intellectual capital (human capital,
structural capital, relational capital) and the dependent variable as capital gains for
investors.
Deris et al (2013) investigate the impact of the added value of intellectual
capital elements on stock returns of companies listed on Tehran Stock Exchange.
Intellectual capital elements efficiency include added value of physical capital,

added value of human capital, and added value of structural capital are used as
independent variables and stock returns as the dependent variable.
Kehelwalatenna and Premaratne (2013) examine the value relevance of
intellectual capital (IC) to investors. In this respect, intellectual capital as
independent variable is associated with the dependent variables which include
contemporaneous market valuation, stock returns, excess returns and share prices
are initially tested. In addition, associations for current IC and future data of the
above stock performance indicators are estimated to investigate whether the
selected performance indicators have delayed response to IC. Pulics VAICTM
method is selected to measure IC and fixed effects panel regressions are used to
analyze data of 191 New York Stock Exchange listed banking sector firms over
2000-2011.
Figure 2.4
An Examination of the Value Relevance of Intellectual Capital: The Case of
Banking Industry Model

VAIC

Market Valuation
Stock Returns
Excess Returns
Share Prices

Note:
Independent Variable
Control Variable
Source: Kehelwalatenna and Premaratne (2013).
Fahim and Yousefnezhad (2012) investigate the effect of intellectual
capital on performance indicators in all industries of companies listed in Tehran
Stock Exchange. The dependent variable is the corporate performance indicators

in terms of Return Stocks, Q - Tobin and the ratio of market value to book value
stocks have provided. The independent variable is the value added intellectual
capital coefficient which was developed by Pulic in order to measure the
intellectual capital. Stock return has been the content of the information for
investors because the performance evaluation based on market value reflects
investors' information well.
Figure 2.5
Effect of Intellectual Capital on Market Criteria in the
Performance Evaluation of Accepted Companies in Tehran SEC Model

VAIC

Stock Returns
Q-Tobin
Market to Book Value
Note:
Independent Variable
Control Variable

Source: Fahim and Yousefnezhad (2012).

Abeysekera (2011) conducted a study which examines the effect of
intellectual capital disclosure (ICD) activity on the current stock return of the top
30 listed firms by market capitalization from 1998 to 2003 in Sri Lanka, a
developing country beset at that time by civil war. The dependent variable is
current stock return and the independent variables are internal capital disclosure,
external capital disclosure, human capital disclosure, and stable capital disclosure.
The model is controlled for firms growth rate and firm size. The model controlled
for past earnings and current earnings as two separate variables in the model.
These are realized earnings and are included in the current stock return.

Figure 2.6
Civil war, stock return, and intellectual capital disclosure in Sri Lanka Model
Internal Capital Disclosure
External Capital Disclosure
Human Capital Disclosure

Current Stock Return

Stable Capital Disclosure

Earning per Share
Market over Book Value
Size of Firm
Source: Abeysekera (2011).

Note:
Independent Variable
Control Variable

Tan et al (2007) investigate the association between the intellectual

capital (IC) of firms and their financial performance. The dependent variable are
return on equity (ROE), earning per share (EPS) and annual share returns (ASR)
which were tested sequentially using the regression model. The independent
variables are value added intellectual capital coefficient (VAIC) which includes
value added capital coefficient (VACA), human capital coefficient (VAHU) and
structural capital coefficient (STVA) which were derived from information
available in the companies annual report for the years 2000 and 2001.
Figure 2.7
Intellectual Capital and Financial Returns of Companies Model
VACA
VAHU
STVA

VAIC

Companies Performance
Return on equity (ROE)
Earning per share (EPS)
Annual share returns (ASR)
Note:
Independent Variable
Control Variable

Source: Tan et al (2007).

Appuhami (2007) investigate the impact of the value creation efficiency
on investors capital gains on shares. This research used the data collected from
listed companies in Thailands stock market and capital gain on shares as the
dependent variable in the equation. The independent variable in this research is
Pulics (1998) Value Added Intellectual Coefficient (VAIC TM) as the measure of
intellectual capital. The research is based on the banking, finance, and insurance
industries in Thailand. The dividend policy of most of the companies in these
industries is to pay no dividend or a very small amount. Thus, the research
examines the capital gain (instead of market return, which includes both capital
gain and dividend yield) in relation to VAIC and its components.
2.2

Dependent Variable Definition

Stock return helps investors to analyze their investment and make the

proper decision. Investors need accurate and qualified information to conduct the
analysis of stock investment in the capital market (Nuryaman, 2013). By knowing
how to value information and forecast return, an investor can gain profit from it
and this leads to a better capital allocation and economic growth.
Sundaja (2003) defined return as the total gain or loss obtained by the
investor in a certain period which is calculated from the dispute between income
on investment during a certain period and initial investment income. Horne and
Wachoviz (1998) explained return as benefit which related with owner that

includes cash dividend last year which is paid, together with market cost
appreciation or capital gain which is realization in the end of the year.
Return can be realized as return which has happened or expected return
which has not happened yet is expected to occur in the future (Jogiyanto, 2000).
According to Kusuma (2011), realized return is very important because it is used
as a measure of corporate performance and is also used as the basis of calculating
the expected return in the future.
According to Jones (2000), return consists of yield and capital gain (loss).
Yield is the cash flow paid on a periodic basis to shareholders (in the form of
dividends), while capital gain (loss) is the difference between the stock price at
the time of purchase and the stock price at the time of sale. Corrado and Jordan
(2000) stated that the return from investment security is cash flow and capital gain
/ loss.
The aim of investors make investment is to maximize their income and
expect their capital appreciate significantly. Investors buy a range of shares which
is known as diversified portfolio and the right selection can deliver capital growth
and a balance of risk and return. Every investment both long term and short term
has the main purpose of gaining benefit which is called return, either directly or
indirectly (Ang, 1997).
The classic valuation theory for stocks is considered from the point of
view that investors systematically predict the future based on currently available
financial data and therefore current stock prices should be a function of these data.
Within the context of an idealized market for a single security, a general model of

investor predictions is created that specifies how investors predict the future given
the past.
Stock valuation is the method of calculating theoretical values of
companies and their stocks. In the view of noted economist John Maynard
Keynes, stock valuation is not an estimate of the fair value of stocks, but rather a
convention, which serves to provide the necessary stability and liquidity for
investment, so long as the convention does not break down. Bakshi and Chen
(2001) develop a stock valuation model in which the expected earnings growth
rate follows a mean-reverting process, and obtain a number of implications for the
price-earnings ratio.

2.3

Relationship between Variables

2.3.1 Relationship between Intellectual Capital and Stock Return

Intellectual capital is the term used to describe the intangible assets
provided to an entity by its employees' efforts and also knowledge assets such as
patents, trademarks, copyrights, and other results of human innovation and
thought. The collection of all awareness and knowledge through which an
organization can obtain competitive advantages is called intellectual capital
(Poureyni, 2012).
In knowledge economy, IC is considered crucial for the competitiveness of
companies regardless of the industry (Makki and Lodhi, 2009). Johnson and
Kaplan (1987) suggest that IC might be the most important consideration
regarding the performance of a company. Intellectual capital plays an important

role in several business sectors which rely heavily on research and development or
human capital for their survival (Djamil et al, 2013). In the new economic era the
intellectual capital assets in companies are seen as the most important force
behind wealth creation in businesses (Firer & Williams, 2003).
One of the most common measurements for intellectual capital, called the
Value Added Intellectual Coefficient (VAIC), was developed by Ante Pulic in
1998. Firer and Williams (2003) stated that VAICTM is an analytical procedure
that enabled management and stakeholders to monitor and evaluate the
effectiveness of value added by each firms resource components.
The research conducted by Kermani et al (2014) through mixed
(combined) data method indicate that there is a positive and significant relation
between thought capital and the expected return by shareholders. Empirical
evidence of Appuhamis (2007) research also suggests that there is a significant
positive relationship between investors capital gain on shares and corporate
intellectual capital. This investigation has shown the potency of corporate
intellectual capital in order to generate capital gain on shares and, as a result,
attract investors in the market. This research is consistent with the researches done
by Fahim and Yousefnezhad (2012) and Lofti et al (2013).
Kehelwalatenna & Premaratne (2012) found negative association of IC
with future stock returns and positive association with future excess returns. They
assumed that investors may perceive IC as firm-specific risk related investments
that accounts for uncertain future benefits. Meanwhile, Fallah and Deslam (2015)
did a research about the impact of intellectual capital and is impact on stock return

and found that there is no significant influence of independent variables toward

dependent variable.
2.3.2 Relationship between Human Capital and Stock Return
Human capital is the stock of knowledge, social and personality attributes,
including creativity, embodied in the ability to perform labor so as to produce.
Human capital is a broad definition but in general when talking about human
capital one refers to the knowledge, skills and abilities embodied in people
(Crook et al., 2011). The knowledge within companies is mostly contained in the
human capital and this is one of the most important resources (Bontis et al., 2000).
Human capital is considered the most important asset of an organization
which not only increases the operational efficiency in using tangible assets but
also creates intangible assets (Lodhi, 2009). Successful companies always invest
in HC to develop their overall working capabilities and environment. Investment
in employee capabilities has direct impact on financial performance of a firm
(Becker et al., 2001).
Firms with good financial performance can increase investors confidence
and attract more investment. When the stock demand of a firm increase, the price
will also increase thus investors can obtain gain in return of their investment. On
the other hand, the money an organization spends on its human capital is
capitalized as a cost in the profit and loss statement and not as an investment
(Petty & Guthrie, 2000). Because of that it is difficult for external investors to
value companies in a reliable way when human capital investment is a hidden
value that mainly is treated as an overhead cost (Pantzalis & Park, 2009).

Appuhami (2007) found that the efficiency of human capital has a positive
influence to the capital gain, although in the study of human capital efficiency has
a weak force in explaining the effect of the capital gain. This research is consistent
with the research done by Tan et al (2007) and Deris et al (2013).
According to the research conducted by Fallah and Deslam (2015), there is
no significant difference between the effect of intellectual capital efficiency and
its components (SCE, HCE, and CEE) on stock return before and after subsidy
reform. Therefore, this indicates human capital played no special role in stock
return of the firms. Similarly with the findings of Vakilifard and Rasouli (2013)
which found that human capital has no association with stock return. The isolated
knowledge that exists in the minds of employees will not benefit from tacit
knowledge unless this knowledge is codified and put in practice in to leverage
from this asset.
2.3.3 Relationship between Structural Capital and Stock Return
Structural capital efficiency include non-human storehouses of knowledge
in organizations such as database, organizational charts, process manuals,
strategies, routines (Nilamsari, 2015). Structuring intellectual assets with
information systems can turn individual know-how into group property (Nicolini,
1993).
Structural capital is deemed as foundation stone for an organization in the
knowledge age (Lodhi, 2009). If the organizational culture, rules, procedures and
system are weak, well-motivated employee capabilities would not be able to add
value to the firm. Strong structural capital possesses supportive environment to its

employees thus increasing productivity & eventually profit and decreasing total
cost of product (Bozbura, 2004). So, it can be pronounced that SC has direct
relationship with financial performance of a firm.
According to the concept of Skandia Navigator Value Scheme (Edvinsson,
1997, Edvinsson and Malone, 1997), major parts of structural capital are customer
capital and organizational capital, which contribute significantly to the changes in
market value of a firm (Lev and Radhakrishnan, 2003). According Putri and Agus
(2013), an organization or a company's ability in fulfilling the routine process of
the company and the structure that supports employee efforts is to produce
optimal intellectual performance and overall business performance.
An improvement on corporate performance can be assumed that the
company's potential in the future and are able to give more profit. Thus, it will
have an impact on investor confidence would increase the sustainability of the
company in the future. As the result, the demand for the stocks will increase
which influence the stock price and investors will gain huge profits when selling
the stock.
In Thailand, the potency of corporate structural capital in order to generate
capital gain on shares was proved by the positive results of Appuhamis (2007)
research. It shows that it is a major asset that can attract investors in the market.
Thus a firm can formulate its business strategies to increase the efficiency of its
resources and achieve competitive advantages over its rivals. This research is
consistent with the researches conducted by Deris et al (2013) and Tan et al
(2007).

In contrast, the result of research conducted by Vakilifard and Rasouli

(2013) did not provide for a positive relationship between structural capital and
firms financial performance. What has been documented in the study is that
investment in organizational structures and databases, computer software, and
increased advertisement might not necessarily lead to improved financial
performance including stock return. This research is consistent with the research
conducted by Fallah and Deslam (2015).

2.3.4 Relationship between Capital Employed and Stock Return

Capital employed is the total amount of capital used for the acquisition of
profits. Capital employed efficiency indicates the value added gained by the firms
from the net book value of assets. Firer and Williams (2003) revealed that South
African firms put more emphasis on utilizing physical assets to gain higher
returns. The empirical findings suggest that despite the efforts to improve its
intellectual capital base the business environment and market in South Africa still
appear to place greater weight on corporate performance based on physical capital
assets.
The efficiency of capital employed occurs when the less usage of physical
capital in the company will generate high revenue. The ability of the company in
the management of capital employed to maximum efficiency and good will attract
the confidence of investors (stakeholders). The increase in stock prices made
investors in the company would benefit in the form of capital gains when selling
shares. However, if a company tends to focus on improving efficiency and

creating value-added capital employed, this will result in excessive expenditures.

Investors viewed as a risk because it shows that the company's going concern is
not guaranteed and later is believed to have an impact on investors' capital gains
earned in the future.
Vakilifard and Rasouli (2013) proved that capital employed (physical
capital) has positive significant on stock return. Deris et al (2013) also found that
the capital employed has a positive impact in value creation process, and it
maintains a significant role in improving firms performance for stakeholders.
These researches are consistent with the research conducted by Tan et al (2007).
Capital employed efficiency shows significant negative relationship with
capital gain on shares in the study of Appuhami (2007). The research did not show
why capital employed has a negative relationship with capital gain, and it may be
due to the special features of the finance and banking sector in Thailand. It is
consistent with the research results Fallah and Deslam (2015).
2.4

Research Model and Hypotheses Formulation

Based on the previous research models which are mentioned before, author

decided to take the model which next to be used in this research, namely from the
journal of Fallah and Deslam (2015) and Appuhami (2007). The differences
between this model and previous research models are different time and place
dimension, and research object. The object in this research is banking industry
listed on Indonesian Stock Exchange from 2011 to 2015.

Figure 2.10
The Effect of Intellectual Capital towards Stock Return of Banking Sector Firms
Listed in the Indonesia Stock Exchange Model
VAIC
HCE

Stock Returns

SCE
CEE
Source: Fallah and Deslam (2015) and Appuhami (2007)
Based on the hypotheses framework above so the hypotheses for this research as
below:
H1:

The intellectual capital has positive significant effect towards stock return

of banking sector firms listed on the Indonesia Stock Exchange.

H2:

The human capital has positive significant effect towards stock return of

banking sector firms listed on the Indonesia Stock Exchange.

H3:

The structural capital has positive significant effect towards stock return of

banking sector firms listed on the Indonesia Stock Exchange.

H4:

The capital employed has positive significant effect towards stock return

of banking sector firms listed on the Indonesia Stock Exchange.