1

Value Added Intellectual Coefficient (VAIC): a critical analysis

Pirjo Sthle, Sten Sthle and Samuli Aho

Abstract
Purpose
The purpose of this study is to analyse the validity of the VAIC method as an indicator of
intellectual capital. We also test Pulics hypothesis that the present market value of a company can
be estimated on the basis of that companys VAIC value.
Design/methodology/approach
The paper describes the Value Added Intellectual Coefficient (VAIC) method through its
calculation formulae and aims to establish what exactly it is that the method measures. It also looks
in detail at how intellectual capital is understood in the method and at how this understanding
differs from the definitions generally accepted in the research literature, and discusses its conceptual
confusions. Furthermore, the paper tests the hypothesis according to which VAIC correlates with a
companys stock market value. This hypothesis is tested against 20062008 financial statement data
for 125 listed Finnish companies. In addition the paper reflects the contradictory results of earlier
studies.
Findings
Our analyses show, firstly, that VAIC parameters have nothing to do with intellectual capital. They
merely indicate the efficiency of the companys labour and capital investments. Furthermore, the
calculation method uses overlapping variables and has other serious validity problems. Second, the
results do not lend support to Pulics hypothesis that VAIC correlates with a companys stock
market value. The main reasons behind the lack of consistency in earlier VAIC results lie in the
confusion of capitalized and cash flow entities in the calculation of structural capital and in the
misuse of intellectual capital concepts.
Practical implications
Our analyses show that VAIC is an invalid measure of intellectual capital.

Originality/value
Our result is important since the method has been widely used is micro and macro level analyses,
but this is the first time it has been put to rigorous scientific analysis.
Keywords
Validity of intellectual capital measures, Value Added Intellectual Coefficient (VAIC),
measurement of company efficiency
Paper type
Research paper

1. Background and aims

Intellectual capital (IC) is a relatively recent line of research that has received increasing scholarly
interest with the continuing growth and development of the global knowledge economy. Several IC
models have been developed in an attempt to operationalize the essence, function and benefits of
IC. These models and tools for the assessment and measurement of IC are ultimately motivated by
the drive to improve overall business performance in the knowledge economy. The methodological
challenge in developing these models is to find ways in which to reliably identify IC and its
economic impact, and on the other hand to find out how IC can be optimized with a view to
boosting economic growth.

Most of the work to date has been based on qualitative research and the building of theoretical
models. Empirical measurements of the economic impacts of IC, on the other hand, still remain
quite scarce. The most important among the latter contributions to the ongoing debate are the
methods developed by Ante Pulic (2000) (VAIC1); Thomas A. Stewart (1997) (CIV2), Baruch Lev
(2001 and 2003) (IDE3 and OC4) and Carol Corrado, Charles Hulten and Daniel Sichel (2004)
(CHS5).
1

VAIC Value Added Intellectual Coefficient

CIV Calculated Intangible Value
3
IDE Intangible Driven Earnings
2

Intellectual capital is a complex issue that is relatively difficult to conceptualize, define and
measure.esearch into intellectual capital has multiplied over the past two decades, and the content
and significance of the concept have received much discussion in the research literature. On a
microeconomic level, 'intellectual capital' refers to the sources of non-physical (added) value for a
company or organization:human capital (e.g. skills, experience, training), relational capital (e.g.
customer and stakeholder relations, brands, agreements) and structural capital (e.g. company
culture, working environment, systems, immaterial rights). By now there is fairly broad agreement
about the structure and scope of intellectual capital, and the research literature generally reflects the
same distinction of intellectual capital between human capital, structural capital and relational
capital. This taxonomical understanding of intellectual capital was first presented by Karl-Erik
Sveiby in the mid-1980s and further developed by Edvinsson and Malone (1997), Sullivan (1998),
Edvinsson (2005) and Andriessen and Stam (2004). On a macroeconomic level, research into
intellectual capital began just after the turn of the millennium, and the measurement methods it used
were mainly based on the categorization presented by Edvinsson and Malone and on the indicators
developed based on that categoriz ation (e.g. Bontis 2004; Andriessen and Stam, 2004, 2005).
Several models based on the formation of company value have likewise been applied in
macroeconomic research (see for example UNPAN, 2003; EIS, 2006, 2007; EU, 2004, 2005, 2006a,
2006b; OECD, 2006 ; WEF, 2006, 2007; Pulic, 2000, 2003; Van der Zahn et al., 2004).
In this paper we focus on VAIC (Value Added Intellectual Capital Coefficient) method developed
by a Croatian professor, Ante Pulic (2000, 2003 and 2005). The purpose of this study is to analyse
the validity of the VAIC method as an indicator of intellectual capital. What does it indicate about a
companys intellectual capital and the creation of value based on it? Does it provide information
about a company that financial indicators do not? In our analyses we also test the hypothesis that
Pulic has put forward: The present market value of a company can be estimated on the basis of that
companys VAIC value. According to the hypothesis VAIC correlates with a companys stock
market value or more generally with its economic performance as measured by return on assets
(ROA) or returns on investments (ROI).

This article proceeds as follows: Section 2 describes the Value Added Intellectual Coefficient
(VAIC) method based on the calculation formulae it uses, and analyses what the method actually
4
5

OC Organisation Capital
CHS Corrado-Hulten-Sichel

measures. It also looks closely at how intellectual capital is understood in the method, and how it
differs from the definitions generally accepted in research literature.
In section 3 we set out to test Pulics original hypothesis to find out whether VAIC correlates with
a companys market value. The most recent tests of this kind were performed in the early 2000s,
and therefore it is interesting to see how the changes in economic drivers during the past decade
may have affected the results. The material for our analysis consists of the 20062008 financial
statement data for 125 listed Finnish companies. In addition we explore in more detail the reasons
for the earlier contradictory results.

2. Value Added Intellectual Coefficient (VAIC)

2.1 VAIC model
Ante Pulic (2000, 2003 and 2005) was one of the first scholars in the field of IC research to focus
explicitly on the connection between IC and economic performance and the first to base his
analyses solely on company balance sheet figures, i.e. financial indicators. Another factor that sets
Pulic apart from the rest of the field is that he straightforwardly applies established IC concepts in
the realm of company economics. His model assigns explicit economic values, value added (VA)
and capital employed (CE), to human capital (HC) and structural capital (SC) and on this basis
generates an unambiguous Value Added Intellectual Coefficient (VAIC) index. VAIC has been
used in various regional and national analyses to study the performance of individual companies. It
has also been frequently quoted in academic research. However, it has not been subjected to critical
conceptual or formal analysis, nor has it been further elaborated.

The VAIC model is intended to measure the extent to which a company produces added value based
on intellectual (capital) efficiency or intellectual resources. VAIC calculations are based on:
a. human capital (HC), which is basically interpreted as employee expenses,
b. structural capital (SC), which is interpreted as the difference between produced added value
(VA) and human capital (HC), i.e. SC = VA HC; and
c. capital employed (CE), which is interpreted as financial capital, e.g. book value.

Based on these definitions and assumptions VAIC is calculated as the direct sum of key efficiency
figures, which in turn are calculated as ratios:
a. capital employed efficiency (CEE) = VA/CE
b. human capital efficiency (HCE) = VA/HC; and
c. structural capital efficiency (SCE) = SC/VA.

As an intermediate result intellectual capital efficiency (ICE) is defined as ICE = HCE + SCE and
finally
VAIC = ICE + CEE
VAIC is thus a relational index in which produced added value is compared to capital employed and
human capital (i.e. employee expenses). When structural capital is zero (or negative), VAIC may
take zero (or negative) values6. The VAIC index normally ranges between 1 and 3, and in practice it
is calculated as the sum of the ratios of value added to capital employed and human capital as
employee expenses.

A more problematic case is that where value added (VA) is close to zero, i.e. value added is close to employee
expenses and structural capital (SC) close to zero. In this case, depending on whether value added is positive or
negative, VAIC switches from - to + . This suggests that the model involves an unstable element originating from
the human capital efficiency (VA/HC) and structural efficiency (SC/VA) definitions.

Value added intellecual coefficient VAIC / Ante Pulic

VAIC = ICE + CEE
Value added intellectual coefficient

CEE = VA/CE
CEE Capital employde efficiency
CE Capital employed

ICE = HCE + SCE

ICE Intellectual capital efficiency

HCE = VA/HC
HCE Human capital efficiency

HC
HC Human capital

SCE = SC/VA
Structural capital efficiency

VA = Out - In
VA Value added

SC = VA - HC
SC Structural capital

Figure 1: Construction of the Value Added Intellectual Coefficient VAIC

2.2 Reflection

The VAIC method calculates both the overall efficiency of a company, and its intellectual capital
efficiency (ICE). VAIC is based on two main assumptions: a) that the creation of a companys
added value is based on the use of physical and intellectual capital, and b) that the added value
created for a company is connected to its overall efficiency. In the model, both intellectual capital
and physical capital are considered as investments.
The use of a companys intellectual capital consists of its assets, the productivity of its accrued
profit and its liabilities. Intellectual capital is capital that consists of the company's employees and
its structure. VAIC is calculated based on the following three stages (see International Business
Efficiency Consulting, 2002, 2003; Pulic, 2002, 2003):

1. The value added (VA) to a company, its human capital (HC) and structural capital (SC) are
calculated. The value added to a company is the difference between the income and expenditure it
generates, which is calculated using the formula:

VA = P + C + D + A
P = company operating profit
C = personnel costs consisting of salaries and social costs
D = Write-downs in companys long-term and current assets
A = Depreciations in company assets

According to the model, a companys human capital (HC) is equivalent to its human resources costs
(HC=C), which are calculated from overall salary expenditure (and human resource investments).
Structural capital (SC) is equal to the difference between the company's previously calculated value
added and its human capital: SC =VA HC = P + D + A. It is worth noting that P, D and A are
strongly affected by company strategies and decision making, D and A are antecedants of prior
investments, and P is determined by present investments.
2. The capital employed efficiency (CEE) of a company, its human capital efficiency (HCE) and its
structural capital efficiency (SCE) are calculated. CEE describes how much value is created in one
monetary unit invested in financial or physical capital. A companys CEE is obtained by dividing its
value added (VA) by its capital employed (CE). CEE = VA/ CE. HCE correspondingly describes
how much a company creates through one monetary unit invested in its human resources. HCE is
obtained by dividing a companys value added (VA) by its human capital (HC). HCE = VA/ HC=
(P+HC+D+A)/HC. With SCE, information can be obtained about how much capital a company can
create through structural capital (SC), and it is calculated by dividing the companys SC by its VA:
SCE =SC/VA.
3. A companys intellectual capital efficiency (ICE) and its value added intellectual coefficient
(VAIC) are calculated. The companys ICE is obtained by adding together its human capital
efficiency (HCE) and structural capital efficiency (SCE): ICE = SCE + HCE. The companys ICE
is obtained by adding together its intellectual capital efficiency (ICE) and its capital employed
efficiency (CEE): VAIC = ICE + CEE and this indicates how much value a company creates in
total per monetary unit invested for each resource (in the area of capital).

2.3 Validity of VAIC: what does it really measure?

Next we will study stage-by-stage what the terms in Pulics VAIC method mean in practice, and
what equivalents there are in a companys accounts.
The value added (VA) of a company is calculated as a sum of its operating profit (P), human
resources costs (C), write-downs of its long-term and current assets (D) and its depreciations of
other assets (A). From these, the value added formula term P+D+A is chiefly comparable to the
companys operating margin.
In Pulics formula, structural capital (SC) is calculated as the difference between a companys value
added (VA) and its human capital (HC) (SC = VA HC). There is, however, no reason to class the
SC variable as structural capital. The calculated parameter SC is purely a traditional accounting and
financial variable, which is comparable to operating margin or operating result.
Human capital efficiency (HCE) is calculated by dividing a companys value added by its human
capital to indicate in practice the real productivity of the companys personnel, i.e. how much value
the company creates through one monetary unit invested in human resources. Officially the
parameter is defined as follows: Value added per human resources cost indicates not only
efficiency but also the labour intensity and economy of a sector. 7 If a parameter is given the value
1, this means that the created value added must have been used completely on human resources
costs. The other efficiency component, the so-called structural capital efficiency (SCE) is calculated
in Pulics model by dividing a companys structural capital by its value added. In reality, SCE
measures how much capital a company can create through one monetary unit invested in value
added, i.e. it measures the productivity or efficiency of value added. The third efficiency
component, the capital employed efficiency (CEE) of a company is obtained by dividing its value
added (VA) by its capital employed (CE), and, as its name suggests, it measures CEE.
In the last stage of the VAIC formula, a companys so-called intellectual capital efficiency (ICE) is
defined, as is its value added intellectual coefficient (VAIC). The companys ICE is obtained by
adding together its human capital efficiency (HCE) and structural capital efficiency (SCE).
However, nothing in the calculation gives reason to talk about intellectual capital, as the variables
7

Definition by Statistic Finland

are purely financial parameters and variables related to labour efficiency. The variable has a clear
connection to the index measuring the real productivity of labour, and is merely a more complicated
version of it, which in reality describes the overall labour productivity of a company.
Finally VAIC is obtained as the sum of a companys overall labour productivity (ICE) and the
efficiency of its capital invested. However, nothing in the calculation in regard to this gives reason
specifically to emphasise intellectual capital. Instead, the parameter is chiefly an efficiency
parameter, which combines labour productivity and capital productivity or efficiency as a parameter
measuring overall productivity.
Apparently the VAIC method operates with the main concepts of intellectual capital such as
structural capital, human capital and the efficiency of intellectual capital. These components
referring to intellectual capital are, however, calculated directly from variables obtainable from
company accounts, and, notwithstanding the concepts of intellectual capital, they do not contain
actual content that refers to intellectual capital. So in reality VAIC measures a companys operating
efficiency in a different way, but its connection to intellectual capital remains non-existent. When
the components of intellectual capital are changed into financial figures in a linear and nonanalytical way, the connection itself to the content of intellectual capital disappears. For example,
since in practice human capital contains factors such as the skills of employees, work experience,
training and motivation, in Pulic's model human capital is reduced to mere human resources costs.
In that case, it is more than clear that the content of the concept itself has decisively changed and we
are no longer talking about the same thing at all. As far as structural capital is concerned, the
problem with the model is similar, and the model does not deal with relational capital at all. Such
being the case, VAIC as an indicator of intellectual capital is misleading. The question is, however,
whether or not it can then provide actual added value in addition to financial parameters already in
use, because in practice (when intellectual capital is stripped of its conceptual apparatus), it operates
in such a linear fashion with parameters in use nowadays.
In addition to conceptual vagueness, the VAIC calculation formula also embodies the following
serious problems concerning internal validity and the interpretation of the parameter:
1. The formula for structural capital (SCE) and human capital (HCE) contain perfect
superimposition and dependency stemming from their definition i.e. they are calculated
derivatives of each other:
SCE = 1 1 / HCE or HCE = 1 / (1 SCE)

10

In practice, this results in a situation where human capital efficiency ICE = HCE + SCE cannot be
meaningfully analysed or interpreted without reference to value added or human capital. This
situation is described in Figure 1.

Figure 1. Intellectual capital efficiencys (ICE) connection to human

capital (HC) and value added (VA).

This is a real problem, as human capital (HC = salary costs in the model) is often interpreted as an
indicator of human capital, so that greater HC means greater human capital (e.g. Corrado et al.,
2004). In calculating the VAIC parameter, however, HCE = VA/HC leads to a situation where
lower HC in the denominator increases human capital efficiency. To a certain extent, this problem
can be eliminated by bearing in mind that

HCE does not measure human capital at a measuring point. It merely measures the use of
human capital.

11

When comparing the ICE and VAIC values of two measuring points, it must be ensured that
the measuring points belong to the same general salary level. One cannot therefore compare
high- and low-salary companies or countries with each other.

3. The use of value added is problematic. Variables D (write-downs) and A (depreciation of

assets) independent of value added VA = P + HC + D + A human resources HC vary
considerably in structure between different sectors. This means that companies operating in
capital-intensive sectors for example the heavy metals industry, the forest industry and
banks gain considerable benefit from this in a measurement where their VAIC value
usually rises irrespective of human and structural capital. At the same time, structural capital
SC = P + D + A (particularly D and A) binds the SC variable and the VAIC parameter so that
it is not possible to compare a) capital-intensive and non-capital-intensive industries and b)
countries rich in capital and countries poor in capital, with each other.

2.4 Conclusion

The purpose of the VAIC method is to measure the efficiency of the use of intellectual capital
(Pulic, 2000). The model changes two components of intellectual capital, human and structural
capital, into financial figures and this forms the value added intellectual coefficient (VAIC).
Analysis of the method led to a conclusion that VAIC parameters have nothing to do with
intellectual capital. They merely indicate the efficiency of the labour and capital that the company
invests. Furthermore, there exists superimposition of variables in the calculation method as well as
other serious problems related to validity, which weakens the reliability of results all the way down
the line.

3. Testing Pulics hypothesis

Pulic has put forward the following hypothesis: The present market value of a company can be
estimated on the basis of that companys VAIC value. According to the hypothesis VAIC correlates
with a companys stock market value or more generally with its economic performance as measured
by return on assets (ROA) or returns on investments (ROI) (Clarke et al 2010).

12

We begin with a description of the empirical results reported by Pulic, and then move on to
compare Pulics method and results with other applications and some of the criticisms presented of
his hypothesis. Next, we report our own application of the VAIC method in which we analyse the
performance of companies listed on the Helsinki stock exchange

from 2006 to 2008 (125

companies in all) and from 2004 to 2008 (94 companies in all)8 and compare our results with those
of Pulic. Finally, we offer our assessment of the accuracy of Pulics hypothesis and present our
evidence-based arguments for that assessment.

Pulic maintains that the present market value of a company can be estimated on the basis of that
companys VAIC value (Pulic 2000). The underlying thinking is that the difference between book
value and market value depends on the companys intellectual capital, and therefore its value can be
estimated by using VAIC. Furthermore if the companys market value is considerably higher than
its value as calculated by VAIC, then the company is overvalued. It is worth noting that if this
hypothesis is true, VAIC could be used both for purposes of evaluating the value of intellectual
capital and the companys feasible market value, for instance in connection with company
acquisitions.
Pulics hypothesis is based on empirical findings alone; and he does not support it by any
theoretical reasoning. He analysed 27 randomly selected FTSE 250 companies9 from 1992 to
1998/99 and discovered that these companies market values correlated with their VAIC scores. The
association is postulated in general terms without transparent statistical analyses of the findings.
Pulic advanced his hypothesis based on the following reasoning (Pulic 2000, 39):
As the results of our empirical analysis have been confirmed by relevant statistical
analysis, which had shown a high degree of correlation between the market value and
the efficiency of resources, it seems logical to go a step further and conclude that this
relationship could also function vice versa. This means that we should be able to
calculate the approximate MV (Market Value, addition by the authors) for any
company via the VAIC coefficient. The following formula is used for calculation:

Finnish stock firms yearbooks, Op-Pohjola and Kauppalehti data bases

London Stock Exchange

13

(1.1.) MV = CE10 (1 rc + VAIC)

All elements are known except the rc (the relation coefficient). How do we define this
unknown element? In all the examples we have shown a smaller or bigger gap
between the trends of MV and VAIC could be noticed. The relation coefficient (rc)
functions as a neutralizer for this gap. The divergences from the real market value
moves between 0.1 15 %. Most of the difference depends on the value of rc: the
more precise the definition of this coefficient the higher the prognostic ability.
Pulic also states that VAIC correlates with a companys economic performance more generally as
measured by return on assets (ROA) or returns on investments (ROI). He maintains that in both
cases higher VAIC scores correlate positively with the effectiveness by which management uses the
companys value creation potential. This, in turn, is reflected in increasing market value and returns
on investments.
Pulics statements and assumptions can thus be summarized in two hypotheses:
H1: VAIC has a positive connection to company market values (MV).
H2: VAIC has a positive connection to company economic performance as measured by general
capital efficiency measures (e.g. ROA, ROI or ROE).

3.1 Earlier research to test Pulics hypothesis

Pulics VAIC model has enjoyed rather more popularity than other economic IC models. It is easy
to apply and calculate based on balance sheet figures alone. In addition to Pulics own work, some
30 studies have been published on VAIC over the past decade.
VAIC has mainly been applied on the company level in developing economies and low income
countries. Most of these studies focus on calculating the level of VAIC within the industrial,
financial or some other sector and are pure applications of the method. The results vary.
Connections between market to book value and VAIC were found in Taiwan (Chang, 2007), but not
in Hong Kong (see Chu, Chan, Yu, Ng and Wong, 2010) or Malaysia (see Gan and Saleh, 2008).

10

CE = capital employed

14

Another line of VAIC research is concerned to test the validity of the method and to analyse its
results. Recently this research has expanded to include assessments of VAICs connection to
corporate efficiency, mainly in terms of return on equity and ROA, (Chu et al 2010) and employee
productivity (Kujansivu & Lnnqvist, 2007).
In Malaysia, Gan and Saleh (2008) found that VAIC can explain the profitability and productivity
of listed companies. They also found a statistically significant positive correlation between ROA
and VAIC variables CEE, HCE, SCE and VAIC. Chu et al. (2010), for their part, found a positive
connection between ROA and CEE and also between ROE and SCE and between ROE and CEE in
Hong Kong listed companies in 2005-2008. Kujansivu and Lnnqvist (2005) reported a positive
correlation between ROI and VAIC, but not between ICE and ROI. Their dataset consisted of an
empirical analysis of Finnish companies financial statements between 2001 and 2003. It includes a
total of 60,304 cases representing the 11 largest industries in Finland.

One recent application is the study by Martin Clarke, Dyna Seng and Rosalind H. Whiting on
Intellectual Capital and Firm Performance in Australia (2010). In addition to using the abovementioned corporate efficiency measures, they employed a time-lag component (current and
previous year VAIC) to find out whether VAIC has explanatory power over time. Clarke et al.
(2010) report that the strongest influence over firm performance is exerted by physical and financial
capital, and furthermore that intangible values are not the main driver of firm success. However
they also point out that there clearly exists a relationship between human capital and company
performance. On the other hand, structural capital appears to have no explanatory power. Although
VAIC significantly correlates with firm performance that performance is substantially explained
only when VAIC is disaggregated. The components of VAIC models explain ROA the most, ROE
the second most, employee productivity the third most, and revenue growth the least. A direct
relationship can be found between VAIC in the prior year and current performance. This
relationship is found with overall efficiency (VAICt-1), human capital efficiency (HCEt-1) and
structural capital efficiency (SCEt-1). The results of Clarke et al. show that the economic effect of
human capital is important in the current year, and it also has a significant lag effect that flows on to
affect performance in the future. The effects of SCE appear to take longer to filter through to firm
performance.

15

In general the earlier studies on VAIC and its performance show a conspicuous lack of consistency.
The following results have been reported by several studies, although each point has also been
contradicted by another set of results:

The components showing the closest correlation with market value and return on equity are
capital employed efficiency (CEE) and human capital efficiency (HCE), whereas structural
capital (SCE) has only marginal impact

The impact of HCE extends over subsequent years, i.e. this component also has a time-lag
effect

VAIC shows a weak but positive correlation with corporate value creation efficiency at the
current point of stock market value measurement

VAIC shows a weak but positive correlation with the companys return on equity.

3.2 Analysis of Helsinki stock exchange with comparison between Pulics results
In this chapter we set out to test Pulics original hypothesis to find out whether VAIC correlates
with a companys market value. The most recent tests of this kind were performed in the early
2000s, and therefore it is interesting to see how the changes in economic drivers during the past
decade may have affected the results. In addition we are keen to explore in more detail the reasons
for the earlier contradictory results.

The material for our analysis consists of the 20062008 financial statement data for 125 listed
Finnish companies. This is a sufficient dataset to test Pulics hypothesis, comprising around 97% of
all companies listed on the Helsinki Stock Exchange in 2008.11 Our analysis therefore provides an
accurate description of the efficiency of resource use by Finnish listed companies. The breakdown
of these companies by industry sector is as follows: energy (1), basic industries (11), industrial
products and services (40), consumer goods and services (16), perishable goods (7), health care (5),
financing (16), information technology (27), datacommunications (1) and community amenities (1).
The VAIC index has been calculated on the basis of average values in 2006-2008 for operating

11

In 2006 the Helsinki Stock Exchange had 140 listed companies; in 2007 the figure dropped to 134 and in
2008 further to 129.

16

margin, depreciations, write-downs of assets and employee expenses. Invested capital was
calculated using the book value of equity.
Table 1 shows the annual averages for the following corporate performance indicators during 2006
2008: value added (VA), overall value creation efficiency (VAIC), overall labour efficiency (ICE),
overall capital efficiency (CEE), real productivity of labour coefficients (HCE) and productivity
coefficients for value added (SCE).

Table 1. Average VA, VAIC, ICE, CEE, HCE and SCE values for Finnish listed companies
(n=125, 2006-2008)
Year

VA
value
added,
million

ICE
VAIC
overall

CEE

SCE

overall

overall

real

productivity

labour

capital

productivi

of value

ty of

added

efficienc efficienc efficienc

y

HCE

2.9
2.8
1.4
2.4

0.4
0.5
0.4
0.4

labour

(labour
+
capital)
2006
2007
2008
2006-2008

462.8
508.1
490.1
485.0

3.3
3.3
1.8
2.8

2.5
2.5
1.2
2.0

0.4
0.3
0.2
0.3

We can see in Table 1 that overall efficiency (labour and capital) and ICE (overall labour
efficiency) consists mainly of HCE (real productivity of labour) and to a lesser extent of CEE
(overall capital efficiency) and SCE (productivity of value added). Table 2 shows the correlation
between VAIC, its components and ROA, market value and market value change.

Table 2: Correlations of VAIC and its components to ROA, MV and annual MV percentage change
(n=94, 2004-2008).

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CORRELATION ROA

MV

MV
Change %

All companies
2004-2008
VAIC

ICE

CEE

HCE

SCE

VA

HC

CE

SC

0.38726

0.01994

0.02226

<0.0001

0.6277

0.6267

0.37049

0.02508

0.02329

<0.0001

0.5418

0.6108

0.28015

-0.08284

-0.01638

<0.0001

0.0432

0.7201

0.19296

0.0129

0.0797

<0.0001

0.7536

0.0811

0.36628

0.02463

-0.05475

<0.0001

0.5485

0.2307

0.10052

0.90579

-0.03207

0.0156

<0.0001

0.4829

0.09822

0.83917

-0.04921

0.0176

<0.0001

0.2804

0.06407

0.37168

-0.02456

0.1151

<0.0001

0.5868

0.09907

0.92177

-0.01745

0.0172

<0.0001

0.7027

Our results differ conclusively from the findings of Pulic, but on the other hand are consistent with
some other earlier results and findings (see Chu et al., 2010; Gan & Saleh, 2008). As illustrated by
Table 2, VAIC and its components (except CE) show a significant positive correlation with return
on assets (ROA), but VAIC does not correlate with market value (only VA, HC, CE and SC). VAIC
does not correlate with market value change either (only HCE).
As is clear from Table 3, no significant correlation could be established between VAIC and market
to book value ratio (MVB).

18

Table 3: Regression analysis results for VAIC versus MVBV (n=94, 2004-2008).

The full correlation analysis is presented in Table 4. Here, sVAIC denotes previous years VAIC.
Table 4: Correlations of VAIC and its components to MVB, ROI and ROE (n=94, 2004-2008).

19

3.3 The conceptual dilemma of Pulics method three experiments to shed light on the
problem
It is confusing that the results obtained with VAIC are so contradictory. We therefore conducted
two experiments and one further elaboration on the use of value added together with IC capitalized
entities. Our aim here is to investigate what VAIC really measures, and on the other hand to find an
explanation for the contradictory results produced with VAIC.
To this end we shall make three modifications to the VAIC formula. We want to find out whether
the confusion surrounding Pulics method is due to conceptual ambiguity. Since VAIC does not
perform consistently, there must be some hidden factors that can explain the inconsistent behaviour
of the model.

Therefore we modify and rewrite VAIC in two ways: 1) we use labour and capital intensity as the
only parameters to test to what extent and how the results are affected change; and 2) we add the
concept of real productivity of labour to the previous result. In the third experiment we examine the
effects of using cash flow entities side by side with capitalized entities. Our purpose here is to
demonstrate that one possible cause for the inconsistency of VAIC lies in the use of value added
(cash flow entity) together with capitalized entities (structural capital and human capital).

3.3.1 First experiment

Most sectoral differences can be described by the concepts of labour intensity and capital intensity.
Both of these measures are sectoral specifics that reflect the structure of the companies within that
sector. On the other hand, labour efficiency and capital efficiency within a given sector are selfevident drivers of companies market values.
To investigate VAIC from this point of view, we rewrite VAIC with respect to employee expenses
(HC), operating profit (OP) and capital employed (CE) using the following settings and
assumptions:
Set HC/CE = r; HC=rCE
Assume OP/CE ROI v ROA v ROE RoR (return on capital resources)

20

The HC/CE ratio can here be taken as a measure of average labour intensity within the sector. The
generalized return on capital resources measure OP/CE RoR, on the other hand, can be taken as
a measure of capital intensity in the sector.

VAIC can now be rewritten in the more general format:

(1.) VAIC = 1 + r + RoR + RoR(1/r + 1/(RoR + r))
VA = OP + HC
SC = VA HC = OP
ICE = HCE + SCE
HCE = VA/HC
SCE = VA/SC
CEE =VA / CE
VAIC = ICE + CEE
VAIC = (OP+HC)/HC + OP/(OP + HC) + CEE
VAIC = (OP/HC + 1) + OP/(OP + HC) + (OP/CE + HC/CE)
VAIC = 1 + (OP/HC + HC/CE) + OP/CE + 1/(1 + HC/OP)
VAIC = 1 + (OP/(rCE) + r) + OP/CE + 1/(1 + rCE/OP)
VAIC = 1 + RoR/r + r + RoR + 1/(1 + r/RoR)
VAIC = 1 + RoR/r + r + RoR + RoR/(RoR + r)
This model of VAIC (1) shows a correlation of r = 0.91 on 2008 actual data. This means that the
rewritten formula comes very close to the original model.

This model discloses that

1. VAIC can be interpreted by using two parameters only, a) general return on capital
resources RoR and b) efficiency of employee expenses or structure of sector in terms of
labour/capital intensiveness.
2. In the calculation of VAIC labour and capital intensity are dominant (the first two terms, r +
RoR, in (1), e.g. the level of r and RoR determines the level of VAIC.
3. Both of these parameters have a direct effect on the behaviour of companies market value
and especially on ROA and ROI, i.e. the linkage between VAIC and companies market
value originates from labour and capital intensity and efficiency.
4. IC concepts are neither needed nor adequate (= HC, human capital and SC, structural
capital).

21

To highlight the dynamics of labour intensity (r) and return on capital resources (RoR), we extract
the ratio between RoR and r as follows:
(1b.) VAIC = 1 + (RoR/r)*(1/r+1) + [r + RoR/(RoR+r)]

This formula clearly demonstrates the dynamics of VAIC: there are two ways to raise VAIC, either
by increasing returns on capital resources (RoR) or by decreasing employee costs. VAIC can thus
be considered as a measure of capital and labour efficiency.

3.3.2 Second experiment

In the second experiment we rewrite VAIC by using the previous result and the concept of real
productivity of labour. The general definition of productivity of labour is the ratio between value
added and employee expenses. Pulic calls this ratio human capital efficiency (sic!).
To further elaborate the connection between VAIC and companies market value, we focus on the
concept of productivity of labour. Within any given sector, labour productivity is a good measure of
efficiency and competitiveness that affect companies market values.

We rewrite the previous model (1.) once more by entering real productivity of labour as a new
parameter:

Set VA/HC = Real productivity of labour = rpl

Set HC/CE = r ; HC=rCE
Assume OP/CE ROI v ROA v ROE RoR (return on capital resources)

Using the calculations of the previous model (1.) for VAIC, rpl can be rewritten in the
following format:
(2.1.) rpl = 1 + RoR/r

VAIC = VA/HC + OP/(OP + HC) + (OP + HC)/CE

VAIC = rpl + RoR/(RoR + r) + RoR + r = 1 + r + RoR + RoR(1/r + 1/(RoR + r));
using (1)

22

rpl = 1 + RoR(1/r + 1/(RoR + r)) - RoR/(RoR + r) = 1 + RoR/r

Model (2), where rlp = HCE = VA/HC, shows a correlation of r = 0.88 with 2008
actual data.
The high correlation shows that VAIC can indeed be written in this way, and the model indicates
that human capital efficiency (HCE) in VAIC can be replaced by the standard of real labour
productivity, i.e. HCE as a concept is misleading.
Substituting (2.1.) by (1) reveals that real productivity of labour (rpl) together with return on capital
resources (RoR) and labour intensity (r) are the dominant factors in VAIC:
(2.2.) VAIC = RoR + rpl + r + RoR/(RoR + r)

This model shows a correlation of r = 0.91 with 2008 actual data and reveals that return on capital
resources (RoR) is a main factor of VAIC. Since RoR by definition correlates closely with all
capital efficiency indices (ROA, ROI and ROE), it is self-evident that this element in VAIC
correlates with general capital efficiency indices.

The two experiments above show that VAIC is closely connected to labour and capital efficiency
together with real labour productivity and that VAIC can be expressed with very little modification
by using these three standard concepts alone.

3.3.3 Third experiment

To further understand the origin of the confusion with the VAIC method, we move on now to
explore whether the use of cash flow entities (value added) side by side with capitalized entities
(human capital and structural capital) causes a problem.

According to Pulic, intellectual capital efficiency (ICE) is the sum of human capital efficiency
(HCE) and structural capital efficiency (SCE). This implies the underlying thinking that intellectual
capital is the sum of human and structural capital:

IC = HC + SC

23

From a semantic and conceptual standpoint this is entirely credible. However, to define structural
capital (SC) as the difference between a cash flow entity (value added, VA) and capitalized entity
(human capital, HC) is catastrophic.

SC= VA-HC

To demonstrate this, we rewrite the structural capital (SC) component in VAIC and arrive at the
following:
(3.1.) IC = VA

Model (3.1.), which seems to be the foundation for VAIC, is based on VA = SC + HC. This means
that, according to Pulic, value added VA equals intellectual capital IC, i.e. a companys intellectual
capital is the same as the value added it produces. However, it is self-evident that value added is
always created by multiple sources and drivers.

Indeed this is where the problems begins. Any attempt to interpret capitalized entities (e.g.
structural capital SC) in VAIC, using cash flow based entities (e.g. value added VA) leads to
absurdities. This can easily be demonstrated:

Set VA/HC = Real productivity of labour = rpl

Using (3.1.) we get

(3.2.) IC = rpl * HC or IC/HC = rpl

This result clearly demonstrates the oversimplification involved in the VAIC model, which leads to
the conclusion that real labour productivity is a simple ratio of intellectual and human capital. Or to
put it in other words: If this were the case, then all three concepts would lose their meaning.
3.4. Conclusion: Pulics hypothesis is false

24

In his paper MVA and VAICTM Analysis of Randomly Selected Companies from FTSE 250
(Pulic 2000), Pulic puts forward his hypothesis that VAIC can be used to calculate an expected,
approximate market value of a company. Our results do not lend support to this hypothesis. On a
component level we detected a weak correlation between capital employed efficiency and the
market value to book value ratio. However, in the context of VAIC calculations this is more a
tautology than a genuine result, since it is self-evident that capital employed efficiency as a capital
efficiency measure correlates positively to a companys market value behaviour. In cases where a
correlation cannot be found, it is hard to find a reason for that since the other components are not
clear and transparent enough. The main reasons behind the confusion and lack of consistency in
VAIC results are as follows:

1. Confusion of capitalized and cash flow entities in the calculation of structural capital
Capitalized and cash flow entities are two different categories that behave in fundamentally
different ways. Value added is a dynamic entity with several internal components that vary
on a daily basis. Capitalized entities are more stable and static and are slower to change. The
main reasons for the contradictory results of VAIC may have to do with the volatility of
value added. Value added is a central element in the VAIC formula and therefore makes it
unstable. This is why the time interval of VAIC measurement also affects the results.
2. Misuse of intellectual capital concepts
It is virtually impossible to see what exactly it is that Pulics formula measures. His use of
IC concepts is confusing, and those concepts add nothing to standard efficiency measures. In
this study we demonstrated that VAIC can be de facto implemented solely by using the
concepts of labour and capital intensity and real labour productivity. Expressed in this way,
VAIC becomes transparent and more readily understandable, and applied in this manner the
results probably become more stable and the deviations become easier to explain.

Furthermore our analysis has shown that the weak positive correlation between VAIC and company
performance can be reduced to the definition of VAIC and its direct connection to a) real labour
productivity and b) returns on capital assets in general. No linkages to IC concepts are needed or
adequate. Finally, based on our analysis we argue that VAIC involves a yet unsettled conception of
IC capitalization via its components of human and structural capital.

25

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