Does investing in intellectual capital improve productivity? Panel evidence from commercial banks in India

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Available online at Borsa Istanbul Review Borsa Istanbul Review 19-3 (2019) 219e227 Full Length Article Does investing in intellectual capital improve productivity? Panel evidence from commercial banks in India Godfred Kesse Oppong a,*, J.K. Pattanayak b a Department of Management Studies, Indian Institute of Technology(IIT-ISM),Dhanbad, Dhanbad, 826004, Jharkhand, India b Department of Management Studies, Indian Institute of Technology(IIT-ISM),Dhanbad, Dhanbad, 826004, Jharkhand, India Received 19 July 2018; revised 27 February 2019; accepted 21 March 2019 Available online 29 March 2019 Abstract In this current knowledge-based economy, firms' productivity and competitive advantage are no longer based on physical and financial assets but on intangible assets. This has compelled knowledge-intensive firms to look for a more reliable source for higher productivity and competitive advantage by focusing on their intellectual capital, which cannot be easily imitated. As banks are classified as knowledge intensive, this study examines investment in intellectual capital by banks and examines how it has improved bank productivity measured in terms of asset turnover (ATO) and employee productivity (EP). Using a panel of 73 commercial banks in India for a 12-year period (2006e2017), the study found that some components of intellectual capital improves productivity, and others do not. Copyright © 2019, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC- ND license ( 1. Introduction Chen, Cheng, and Hwang (2005) stated that banks are sources of economic value, and higher productivity comes from their in- In recent years, global banking has been transformed by tellectual capital (IC). This phenomenon has made the concept of knowledge as a source of wealth, compared to other tangible and IC popular in the current era of knowledge economies, building physical assets (Bontis, 1998). Knowledge has become the new on the knowledge-based theory (KBV) of a firm. Barney (1991) engine driving organizations' wealth, and the World Bank (1999) considered these intellectual assets resources that can be phys- stated that “knowledge is our most powerful engine of produc- ical capital, organizational capital, and human capital resources. tion.” Banks as service firms have been classified as a knowledge- Additionally, the resources are exactly what Pulic (1998) intensive sector (Branco, Delgado, Sousa, & Sa, 2011), and referred to as the components of IC that form the value- studies explore the relevance of knowledge to bank performance added intellectual coefficient (VAIC) model. This model is (Edvinsson & Malone, 1997; Firer & Mitchell Williams, 2003; useful in evaluating IC and in distinct features of organizations Kamath, 2015). This makes the recognition and development of (El-Bannany, 2008). The model combines capital employed knowledge management (intangible asset) an important aspect of and human and structural capital efficiency, which enables bank management. Originally, the entire operations of banks comparative analysis between firms, sectors, industries, and depended on creativity, offering edge products and providing countries. Some studies (Mondal & Ghosh, 2012; Onyekwelu, unique services in creating competitive advantage. Therefore, Okoh, & Iyidiobi, 2017; Soriya & Narwal, 2015) that have investigated IC and bank performance have suggested that IC contributes to performance as an indicator of productivity, * Corresponding author. profitability, or efficiency of firms. Therefore, investigating IC E-mail addresses: (G.K. Oppong), jkpattanayak@ in the banking sector is imperative because the sector is (J.K. Pattanayak). classified under knowledge concentrated/intensive firms. Peer review under responsibility of Borsa Istanbul Anonim S¸irketi. 2214-8450/Copyright © 2019, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license ( 220 G.K. Oppong, J.K. Pattanayak / Borsa Istanbul Review 19-3 (2019) 219e227 Acting mainly as a financial intermediary, banks offer intangible or tangible (Barney, 1991). Based on this theory, indispensable services to stimulate and promote economic scholars and practitioners opined that in this current knowledge growth. In doing so, banks require physical and other intel- era, intangible assets, also known as intellectual capital (IC), are lectual assets for production (Goh, 2005). Moreover, in India, what make the difference in firm performance (e.g., Edvinsson according to World Bank Group, 2017, about 46.2% of total & Malone, 1997). Similarly, Pulic (1998, 2000) put forth a production comes from the service sector, including banks. model known as value-added intellectual coefficients (VAIC), This means that bank productivity is an important element in which measures a firm's intellectual efficiency in this current the development of the Indian economy. Many studies have knowledge economy. According to Pulic (2000), the model is been conducted on Indian banks (Kamath, 2007; Mondal & related to the physical/financial, structural, and human capital, Ghosh, 2012; Soriya & Narwal, 2015), however, few are on which creates value for firms (See Figure S1, available online). IC and bank productivity alone. Also, none of the studies From a general perspective, human capital efficiency focused on commercial banks with emphasis on how IC in- (HCE) as a component of the VAIC model constitutes the fluences bank productivity. So the question remains as to how knowledge of employees and their competence (Bontis, 1998) IC influences commercial bank productivity. This study, which does not remain at the organization after the concerned therefore, covers commercial banks with high market capi- employee leaves. Regarding this component, Goh (2005) talization and the disclosure of IC has been recorded by provided evidence that HCE is the most dominant IC commercial banks in recent years. component and hinted that staff knowledge in the creation of Aside from this, the growing internalization that has been value is indeed a sacrosanct aspect for banks. Similarly, in driven by the continuous deregulation has increased competition India, using a sample of 30 firms across manufacturing and and technological advancement in the Indian banking sector. services, Kamath (2015) assessed IC and performance and Boden and Miles (2000) have hinted that these transformations found that HCE was the major component of IC with an are considered features of a knowledge-based economy. impact on productivity. Mondal and Ghosh (2012) also Deregulation, for instance, reduced public monopolies, which confirmed the positive significant relationship between HC encouraged foreign banks to operate, creating a more competi- and bank productivity. Tripathy, Gil-Alana, and Sahoo (2015) tive environment that is conducive to innovation and growth. assessed the relationship between 164 firms in seven industries This is because these foreign banks are already advanced in (including banks) and found a high impact of HCE on firm technology and acquainted with international banking standards performance. Nimtrakoon (2015) found similar results, and practices, hence desire high competition in the industry. This consistent with those of Wang et al. (2011), that HCE signif- is why in the second phase of the Narsimham Committee icantly affects firm performance. In addition, studies on India recommendation in 1998 stated that the Indian banking system is by Maji and Goswami (2016) documented similar results, completely outdated and needs technological support in this indicating that HCE affects firm performance. knowledge era (RBI report, 1999). Based on these studies related to HCE and performance, we Because of these drawbacks, banks ought to be techno- form the following hypothesis: logically sound and be more innovative to be able to compete. H1. HCE has a positive impact on bank productivity To build and maintain a sustainable competitive advantage, The second component of IC, capital employed efficiency banks face a critical moment in managing their intellectual (CEE), is defined by Pulic (1998) as including all necessary assets, given that they rely on their intangible assets to excel. financial funds and physical capital, therefore, CEE is an That is, banks' potential in building their competitive advan- important consideration in the VAIC model. Scholars tage relies on the investment and efficient management of IC including Chen et al. (2005) found CEE to be positive and (Al-Musali & Ku Ismail, 2016). This is why it is so important significant with corporate measures such as EP and ROA. to examine how investment in IC has influenced productivity Consistently, Chan (2009b) primarily assessed the impact of of commercial banks in India. IC on organizational performance, revealing that CEE is The study therefore applied the VAIC model with a sample positive with all performance measures, including productiv- of 73 commercial banks over a period of 12 years. A separate ity. Also, a study on Serbian hotels by Bontis, Jano sevi c, and analysis has been done by dividing the full sample of banks D zenopoljac (2015) showed that capital employed was an into public, private, and foreign banks. The sample is sourced effective component of IC, which drives the productivity of the from the Prowess database and panel data modeling featuring sample hotels. In India, studies by Venugopal and Subha fixed and random effects were applied for analysis. Hence, the (2012), Tripathy et al. (2015), and Maji and Goswami study comprises five sections, and the next section discusses a (2016) found a significant correlation between CEE and literature review, followed by sections on our methodology, financial performance measures. Consistent with these studies, findings, and discussion. Deep and Narwal (2015) found a significant association be- tween CEE and productivity at Indian firms in the 2. Literature review and development of hypotheses manufacturing and service sectors. A study on Turkish banks by Ozkan, Cakan, & Kayacan, 2017 similarly records a strong One of the most recognized theories of a firm is the resource- association between CEE on bank performance for a period of based theory (RB theory), which recognizes the resources of a 10 years (2005e2014). These studies show that different firm as human, physical, or organizational and could be G.K. Oppong, J.K. Pattanayak / Borsa Istanbul Review 19-3 (2019) 219e227 221 authors in different geographic areas have all verified that CEE on the banking sector in India. And the existing studies did not has a positive influence on either productivity or profitability. employ both of the main productivity measures, employee Based on the results in different studies as discussed above, we productivity and asset turnover, to assess the IC effects on formulate the following hypothesis: commercial bank productivity in India. Hence, this study at- tempts to fill the existing gap in the literature by assessing a panel of 73 banks with the application of VAIC model to H2. CEE has a positive influence on the productivity of banks address the following question: Does investing in IC affect Regarding structural capital (SC), which includes a firm's pro- productivity at commercial banks? We contribute to the cess manuals, strategies and databases are properties owned by existing literature and help banks to understand how produc- the organization (Riahi-Belkaoui, 2003) and continue to provide tivity is influenced by IC over different times series. a supportive environment for employees, which in turn helps in building up productivity (Bozbura, 2004). Assessing the rela- tionship between SCE and firm performance, the findings of 3. Data description and methodology Rehman, Chaudhary, Rehman, and Zahid (2011) were consistent with the results of Nimtrakoon (2015) that SCE and performance 3.1. Data are highly correlated. The same result is found by Bontis et al. (2015), who confirmed that SCE has a significant relationship The data come from the Reserve Bank of India database with productivity. More so, studies on Indian banks (Maji & and annual financial reports of banks that are available in the Goswami, 2016; Tripathy et al., 2015) also revealed that SCE Prowess database (a center for monitoring the Indian econ- has a major impact on the performance of firms measured by omy). The sample consists of a panel of 73 commercial banks, ROA. Similarly, a study on Indian banks by Soriya and Narwal including private, public, foreign, and regional rural banks, (2015) showed that SCE has a significant impact on employee for twelve years, from 2006 to 2017. The main motivation for productivity. Although few studies found an insignificant rela- choosing this study period is to cover the global financial tionship between SCE and performance as measured by pro- crisis, which affected most economies. As India became in- ductivity or profitability, most studies observed that SCE tegrated into the global economy after globalization, liber- positively affects firm performance. Consistent with these ob- alization, and deregulation, the country was not unaffected by servations, we formulated the following hypothesis: the 2008 crisis. The effects included having growth in the gross domestic product, with a mean of 9.4 percent over three H3. SCE has a positive impact on bank productivity succeeding years (2005e2008), decline to 6.7 per cent in the Nevertheless, IC combines components such as capital financial year 2008e9. Moreover, some banks commenced employed and human and structural capital efficiency to operation in 2004, and with a goal of capturing all the com- construct the VAIC model (Pulic, 1998). Previous studies mercial banks in order to generate findings with far-reaching (Chen et al., 2005; Clarke, Seng, & Whiting, 2011; generalizability, choosing a period earlier than our selected Mohiuddin, Najibullah, & Shahid, 2006; Mondal & Ghosh, time period could have reduced our sample data. Overall, firm 2012) have documented the connection between VAIC and inclusion in our data is based solely on the availability of firm performance. To demonstrate, Chen et al. (2005) and financial data for each period. We performed vigorous Mohiuddin et al. (2006) confirmed that IC is a major source of screening, and any missing firm-year observations are value creation at banks. In the same arena, Clarke et al. (2011) excluded from the data. In the end, our sample comprises found that IC affects the performance of manufacturing firms balanced panel data of 73 commercial banks with 876 firm- in Australia. In Asia, Mondal and Ghosh (2012) examined the year observations. Panel data are ideal for this study influence of IC on performance at Indian banks, and their because they study the dynamics of change among our sample results indicate a significant correlation between VAIC and groups, which time series or cross sections alone cannot performance. These studies established a positive relation produce. among all components and confirmed that VAIC affects firm productivity. Based on this empirical evidence on VAIC and 3.2. Variable definitions firm performance, we formulated the following hypothesis. Following most of the prior studies (see Clarke et al., 2011; Kamath, 2015; Mondal & Ghosh, 2012; Onyekwelu et al., 2017), H4. VAIC has a positive impact on bank productivity in we define the variables used in the study as shown in Table 1. India The empirical literature demonstrates the relevance of IC in 3.2.1. Dependent variables enhancing firm productivity (Bontis et al., 2015; Chen et al., Patton (2007) writes that a firm's productivity relies on its 2005; Kamath, 2015; Mondal & Ghosh, 2012) and firm IC more than on physical assets. This means that investing in profitability (Maji & Goswami, 2016; Tripathy et al., 2015), IC subsequently permits the reduction of average production which is empirically tested for different firms, industries, cost and perhaps increases the firm's operating margins sectors, and countries. However, only a few studies (Mondal & (Nakamura, 2001). According to the literature, most previous Ghosh, 2012; Soriya & Narwal, 2015) have been undertaken studies link IC influence with productivity measured by EP or 222 G.K. Oppong, J.K. Pattanayak / Borsa Istanbul Review 19-3 (2019) 219e227 Table 1 Description of variables used in the study. Variable Type Variable name Variable abbreviation Measurement method Dependent Employee Productivity EP Pre-tax income/number of employees. (a measure for the net valued added per employee) Asset turnover ATO Revenue/total asset. (Productivity indicator which measure efficiency of asset in generating revenue. Independent Human Capital Efficiency HCE HCE¼VA/HC Capital Employed Efficiency CEE CEE¼ VA/CE Structural Capital Efficiency SCE SCE¼ SC/VA Value Added Intellectual Capital VAIC VAIC¼ HCE þ CEE þ SCE Control Firm size SIZE Log (Total assets) Leverage LEV Total debt/Book value of total assets Crisis Crisis A dummy variable taking the value of 1 for the years of 2008 and 2009, and the value of 0 otherwise. Note: Value Added Intellectual Capital model (VAIC) developed by Pulic (1998; 2000) is used to measure intellectual capital on productivity of commercial banks operating in India. The model follows a number of phases as follows where VA¼ Output-Input (Output ¼ Gross income & Input ¼ operating expense); HC ¼ employee cost; CE ¼ physical capital; SC ¼ VA e HC. ATO (see Gan & Saleh, 2008; Clarke et al., 2011; Maji & 3.2.3. Control variables Goswami, 2016; Phusavat, Comepa, Sitko-Lutek, & Ooi, To minimize the effect of other variables that could explain 2011; Tripathy et al., 2015). We measure bank productivity bank productivity and lead to model misspecifications, the using ATO and EP, following the literature. study added leverage and firm size as control variables. Ac- cording to Riahi-Belkaoui (2003), the leverage ratio is one of Asset turnover (ATO) is calculated as revenue/total assets. the fundamentals in a firm's performance and value creation. A measure of bank productivity from the use of assets to Hence leverage (total debt/total assets) has been used to con- generate sales, ATO has been used in the literature on trol for the effect of liabilities on bank productivity (see Clarke studies conducted in India and other economies (see Firer et al., 2011; Kamath, 2015; Mondal & Ghosh, 2012). Also, the & Mitchell Williams, 2003; Mondal & Ghosh, 2012). natural logarithm of total assets is there to control for firm size Employee productivity (EP) is calculated as pre-tax in- effects on wealth creation (see Deep & Narwal, 2015; Firer & come/number of employees. It measures each employee's Mitchell Williams, 2003; Kamath, 2015). Finally, because the net value added, which reflects employee productivity. EP financial crisis is one of our main reasons for choosing the has been used in the literature on studies conducted in study period, we included a dummy variable to control for the India as a measure of bank productivity (see Soriya & impact of financial crisis (CRISIS ), which takes a value of 1 Narwal, 2015). for 2008 and 2009, and 0 otherwise (see Al-Musali & Ku Ismail, 2016). 3.2.2. Independent variables (VAIC model) 4. Methodology and model construction The VAIC, developed by Pulic (1998, 2000) as a measure of efficiency of IC, has attracted attention from s
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