Social Capital Links between Management Decision-making,
Intellectual Capital and Market Performance
Laurence Lock Lee
Computer Sciences Corporation and
Macquarie Graduate School of Management
Over the past decade or so Intellectual Capital (IC) research has focussed on building understanding through reducing IC into its component parts. IC measures within IC statements have been designed to parallel traditional financial based reporting. While these efforts have helped to build our understanding of IC, the adoption of IC reporting by mainstream business has not been forthcoming. The lack of standards and the plethora of available measures can work against their use in management decision-making. Social Capital (SC) is proposed as a unifying concept for IC and hence market performance. A review of the literature is used to build arguments in support of SC as a unifying concept. The representativeness of the core IC elements of human capital, internal/structural capital and external capital in SC is shown. An additional argument for SC is its intuitiveness and the ability for executives to naturally “sense” SC performance. A tentative SC measurement approach is proposed based on mining relationship information from corporate and publicly available information. A relationship mining approach makes SC monitoring in corporate environments feasible, and minimises the need for continuous and intrusive staff surveys. Examples of sociograms derived from relationship mining are provided to illustrate the approach.
The traditional line of enquiry for using intellectual capital (IC) and intangible assets (IA) influence on market performance, is to use IC statements to communicate the firm‟s value proposition to market actors. Since Skandia published its first IC
statement in 1995, it is fair to say that the practice has not captured the imagination of mainstream management. The inability to effectively communicate the content and value story through the IC statements is seen as a key barrier to progress (Johanson, 2003). Attempts to simplify IC elements into single indices or a smaller suite of elements have suffered similar ambivalence from market actors. While efforts to introduce and standardise IC compliance reporting are admirable and necessary, history with conventional financial reporting standards has shown that the pace of adoption could stretch generations before a sufficient critical mass of reporting is achieved. In the mean time we need other mechanisms to assist executives leverage intangible values.
The literature to date has focussed on reducing the IC concepts into more discrete component parts for more detailed analysis and improved understanding. Little attention has been paid to synthesis of these component measures into unifying concepts that can practically aid in management decision-making. This paper steps back from a focus on IC statements and looks at using social capital (SC) as a unifying construct to assist executive managers both manage and report on intangibles. SC has its historical roots in public welfare, but more recently is gaining the attention of the corporate sector (Cohen, D. and L. Prusak, 2001). SC has been shown to be interrelated with IC and organizational performance (Nahapiet, J. and S. Ghoshal, 1998).
SC measurement schemes, using social network methods, can arguably provide executive management with simpler metrics for supporting management decision-making and lucid value creation story lines for communicating with market actors. Social network measures applied to markets can provide an indication of those organisations that are preferentially placed in the network of suppliers, customers, partnership and alliances that comprise a marketplace. Traditional social capital measures derived for public welfare applications (Stone, 2001, World Bank, 2003) can be adapted to measure relationship values at the inter and intra-firm level. As an alternative line of enquiry, SC may provide the missing link between intangibles and market performance.
The following sections will cover:
a) A review of current SC measurement schemes and how they might be applied
in a corporate context.
b) A brief literature review is provided that develops the linkages between SC
and Market performance through IC and management decision-making.
c) Preliminary measurement propositions, illustrated by examples.
2 SOCIAL CAPITAL AS A UNIFYING MANAGEMENT
Social capital can be defined as “The stock of active connections among people: the
trust, mutual understanding and shared values and behaviours that bind the members
of human networks and communities and make co-operative action possible” (Cohen
and Prusak, 2001, p4). Social Capital as a concept has its roots in the field of sociology, being largely applied to describe organisational effects developed through socially derived connections in the broader communities, societies and cultures (Baker, 2001; Nahapiet and Ghoshal, 1998). Traditionally, the context of SC for private sector firms is seen as their contributions (usually financial) to the communities within which they operate. While often seen as corporate philanthropy, claims have been made that such good corporate citizenship can contribute to improved business performance (Allee, 2000; Roman, Hayibor and Agle, 1999). The traditional view of social capital, as described above, is “industrial era” thinking. Many commentators have argued that we are currently transitioning from the industrial era to a knowledge era (Drucker, 1993; Savage, 1996), where the traditional factors of production of land, labour and capital are being replaced by the creation of value through knowledge. In the knowledge era, firms are becoming embedded within a complex web of interconnections that span markets, governments and communities. In this world the concept of social capital can take on a whole new dimension for the “firm”.
The following table identifies common themes for SC as identified by the Australian Bureau of Statistics discussion paper on measuring Social Capital (ABS, 2000), and a potential corporate interpretation:
Current Societal Context Possible Corporate Context
Social Networks and Support Communities of Practice, Industry
Empowerment and Community Membership of Communities of
Participation Practice or Industry bodies
Civic and Political Involvement “Bottom up” initiatives; Industrial
Trust in People and Social Institutions Trust in Management. Trust in
Tolerance of Diversity Cross functional teams, cross industry
Altruism and Philanthropy Investment in local communities,
Table 1- Traditional verses corporate context for Social Capital
The increasing importance of intangibles was initially identified by Sveiby in his work on “Company Knowhow” (Sveiby, and Risling, 1986). Since this time a plethora of literature has been published in support of new methods for measuring and managing intangibles (Sveiby, 1997; Edvinson and Malone, 1997; Lev, 2001a; Johanson et al, 1999). From Sveiby‟s Intangible Asset Monitor (Sveiby, 1997) and
Kaplan and Norton‟s Balanced Scorecard (Kaplan and Norton, 1996), increasingly sophisticated scorecards have been built (Wall and Doerflinger, 1999; Liebowitz and Suen, 2000; Mouritson et al, 2000). Intangible Capital has been decomposed into intellectual capital, structural capital, human capital, customer capital, innovation capital, external capital, stakeholder capital, knowledge capital. Many of these concepts are interdependent and difficult to measure and operationalise. As an adjunct to the traditional balance sheet or profit and loss statement, they may eventually become useful analytical tools.
The literature to date has been focussed on expanding the concept of intangibles into ever increasing sub-components. Little research has addressed the need to now reduce this suite to the smaller set of heuristics that mangers will need, to manage intangibles on a day-to-day basis.
The proposition is that SC is a leading driver and source of managerial heuristics for creating increased intangible asset value, subsuming a majority of other intangible concepts. An organisation exhibiting excellent social capital would be seen as one where internal departments are heavily interconnected, sharing a common vision and language. The firm would also exhibit similar traits externally, easily forming profitable alliances and partnerships to improve its overall market performance. Human interaction is a fundamental premise for building social capital. It has also been argued that the human dimension accounts for at least half of all IC value to an organization (O‟Donnell and Berkery, 2003).
The following schematic summarises various SC measurement schemes (Stone, 2001; ABS, 2000; Borgatti, Jones and Everett, 1998; World Bank, 2003):
Measurement FrameworkSocial CapitalSocial Capital
Structural Structural QualityQuality
•Social trust•Network size
•Giving, volunteering•Network Constraints
•Faith based engagement•Closeness
•Informal social ties•Betweenness
•Diversity of Friendships
•Equality of civic engagement
Figure 1– Social Capital Measurement Schemes
SC measures have two dimensions, quality and structural. The quality of social relations can be divided into social trust, which is personal, and Institutional trust, which works at an organisational level. Reciprocity refers to “in-kind” exchanges that
are not necessarily economically based, typically “returned favours”. Measurement constructs form the basis of SC survey instruments, where typically respondents are asked to rate these dimensions along a qualitative scale. The constructs provided are just a sample typical of those used in an SC quality survey.
The structural network measures are based on measuring connections. Survey respondents are typically asked whom they connect or interact with (i.e. nominate their “ties”). Often the relative strength of a tie e.g. strong, moderate, weak is also collected. A social network map (sociogram) can be generated from the data collected to assist with visualising the nature of connections. Statistical calculations on the number and nature of ties can then provide measures like network size, density, heterogeneity. Using demographic information collected about the respondents, the networks can be studied at the individual or aggregate (firm, organisation or national) level. These measures in turn can be used to infer dimensions like degree of formality, spatiality, relationships.
More recently, network maps are being drawn from information mined from electronic sources e.g. discussion groups, e-mail, Internet (Lock Lee, 2003, Bontis, 2003, Tyler, J., D. Wilkinson, et al.,2002), which obviates the need to rely on expensive and intrusive survey methods. SC measures will need to be a combination
of survey and electronic content analysis methods in order to achieve an acceptable level of objectivity and reliability.
Collectively, the structural and quality measures provide a snapshot of SC (and potentially IC) of the population under study. The SC report would have two parts, covering the quality and structural dimensions. The quality part of the survey would ask respondents to provide a rating for questions reflecting support for dimensions like collaboration, inter-business unit trust, quality of alliance partnerships etc.. The survey data would be processed to provide a picture of the state of SC (and therefore IC) for the population under study. In effect SC is a lens through which IC is viewed, as illustrated below:
Social Capital LensSocial Capital Lens
NGO ANGO ANGO AFirm AFirm AFirm AGovernment AGovernment AGovernment AGovernment BGovernment BGovernment B
Community participationCommunity participationCommunity participationCivic EngagementCivic EngagementCivic EngagementTolerence of DiversityTolerence of DiversityTolerence of DiversityVolunteering/AtruismVolunteering/AtruismVolunteering/AtruismSocial TrustSocial TrustSocial TrustInstitutional TrustInstitutional TrustInstitutional TrustPolitical ParticipationPolitical ParticipationPolitical ParticipationSC highs and lows
IC StatementIC Statement
--Human competenceHuman competence
--Internal structureInternal structure
--External structureExternal structure
Figure 2 – Social Capital Lens
3 SOCIAL CAPITAL AND MARKET PERFORMANCE
In this section a brief literature review is provided to illustrate the potential connection between Social Capital and Capital Market Performance (MP). The principal research proposition is that SC can, through informing executive management decision-making, have a direct impact on share market valuations. This proposition is unique to the extent that no literature could be identified that specifically addresses this proposition fully. Therefore the intention is to build support for this proposition through critically reviewing the literature which indirectly
supports the influence of SC on MP through its influence on firstly IC / IA, then organisational performance (OP) and finally MP.
Intellectual Social Capital Capital Market Organisational Capital LeversPerformancePerformancePerformance
Figure 3 – Framework for SC to MP Review
Identifying how this proposition can be tested is outside the scope of this review, but for completeness, the following mechanism is offered:
; Capital market performance has previously been defined as total
shareholder return and is readily measurable using publicly available
information for listed companies.
; Intangible Asset Performance could be measured using the proxy of
market to book ratios.
; Good organizational performance can be problematical, as in the literature
this often refers to any outcome that the authors feel is beneficial to the
organization. It could however be represented by a common suite of
balanced scorecard or intangible asset monitor measures.
; The impact of SC interventions could therefore potentially be tested
through its impact on market to book ratios and balanced scorecard metrics.
These measures could in turn be tested against total shareholder return.
The attention to the importance of intangible assets has grown in concert with the growing gap between market valuations and book valuations. The phenomena began in the early 1980‟s and by the 1990‟s the trend was entrenched. The dot-com crash
provided a sobering lesson on the fragility of intangibles driven share prices. The intangible balance sheet was a plausible response to the phenomena (Sveiby, 1997). IC statements were largely inspired by the need to find an alternative accounting mechanism (Lev, 2001a) for intangibles. Many flavours of IC reporting have subsequently been created using a plethora of metrics for intangible elements (Bontis, N., Dragonetti, et al., 1999). More recently, researchers have recognised that numerical indicators are not sufficient for communicating the value proposition around intangibles and have introduced narrative techniques as an adjunct to the numbers (Moritsen et al, 2002). The use of SC elements can be seen as another diversion or adjunct to numerical measures.
The following table summarises selected critical literature that address each of the links in the influence chain from SC to MP:
Author SC IC/IA OP MP
Nahapiet and Ghoshal, 1998 X X X
McElroy, 2002 X X X
Hazleton and Kennan, 2000 X X
Pearce and David, 1983 X X eBurt, 2000 X X eGargiulo and Rus, 2002 X X X eRowley, T., D. Behrens, et al. (2000). X X
Allee, 2000 X X eLow, 2000 X X X eHurwitz et al, 2002 X X X
Holland, 2003 X X X
Mouritson, 2002 X X
Johanson, 2003 X X
Wurzburg, 1998 X X eBosworth and Wharton, 2000 X X
Mouritson, 2003 X X
Edvinsson, 2000 X
Simon, 2001 X X
Table 2 – Literature focus by research element
e =Papers that have an empirical research component.
Table 2 identifies the research elements addressed by the literature selected for review. This selection is somewhat representative of the literature at large. There are numerous publications linking SC to OP, a few relating SC to IC and no literature attempting to link SC directly to MP as yet. The IC literature has concentrated on the linkages between IC/IA and OP but also demonstrates a healthy fascination with the impact of IC/IA on MP. The latter has largely been driven by the phenomenon of rapidly increasing market to book ratios over the past two decades. Overall, the literature reflects the immaturity of the field, with a majority of papers proposing new theories or propositions based on academic argument. Empirical research papers are largely limited to quantitative studies of publicly available financial or market metrics and quantitative studies using social network analysis.
3.1 Relating Social Capital to Intellectual Capital
Both SC and IC are new disciplines, with the bulk of the literature being developed over the past decade or so. The SC and IC research themes had developed independently until the late 1990s, when Nahapiet and Ghoshal published their seminal work on “Social Capital, Intellectual Capital, and the Organizational Advantage” (Nahapiet and Ghoshal, 1998). In this work they proposed that a firm‟s capability to create SC provides a conducive environment for IC creation. They posit that firms are better placed to create social capital than markets, with consequential organisational advantages.
The ability of firms, as social communities, to specialise in creating and sharing knowledge was seen as offering a contrasting “theory of the firm” to the traditional transaction cost theory. The “theory of the firm” discussion relates to what should be
kept inside the organisation and what should be left to the market. The authors draw in the work of Nobel Laureate, Herbert Simon, who agrees that efficiency of communications, rather than transactions, should be the determinant. Simon also acknowledges the important role that social and behavioural dimensions play in efficient communications and hence organizational performance (Simon, 2001).
The following model summarises the argument that the Nahapiet and Ghoshal follow for linking social capital to the creation of new intellectual capital. IC creation is seen as being created through the combination and exchange of knowledge. SC provides the mechanism that maximises knowledge combination and exchange.
Figure 4 –SC/IC model (Nahapiet and Ghoshal, 1998, p251)
One can see from this model that their characterisation of IC is more related to general knowledge management concepts than the particular characterisations of IC that have emerged from Scandinavia and Sveiby‟s work on intangible assets (Sveiby, 1997). Interestingly enough, their decomposition of SC into structural, cognitive and relational dimensions, in building their arguments, is not dissimilar to Sveiby‟s decomposition of IC into Human, Internal and External capital dimensions used to build an argument for IC impacts on organizational performance.
An alternative construct linking SC to the traditional IC elements is provided below:
Figure 5 – Social Capital and IC
Figure 5 demonstrates the relationship between IC, as it is traditionally characterised, and SC. Some elements of IC are commonly defined as part of SC e.g. an individual‟s social network, a firms alliance structures, stakeholder relationships are both SC and IC elements and provide a tangible linkage between SC and IC. Other IC elements like reputation, patents, skills and experience, that may not be explicitly defined as part of SC, do contribute to SC by acting as “attractors” for potential connections, and therefore SC development. For example, a firm looking to develop an alliance arrangement with another firm will be attracted by elements like reputation, brand and the skills and experience of the staff in these prospective organisations. One could therefore argue that an organisation achieves excellent SC by collectively maximising its external, internal and human capital.
McElroy (2002) has since argued that the traditional IC constructs have been remiss in not specifically including social capital within its constructs. He provides an alternative scheme by using the IC construct developed by Edvinsson (Edvinsson and Malone, 1997) to illustrate where SC fits. McElroy coins the term “Social Innovation Capital” to promote an argument that organisational advantage is the result of innovation and that innovation is socially constructed.
Allee (2002) has similarly criticised the current traditional treatments of IC for their limited focus on the commercial enterprise and their disregard for environmental and social responsibilities. Allee goes on to re-define “value” in macro-economic terms,
adding social citizenship and environmental health into an expanded IC framework.