Eisfeldt & Papanikolaou (2013): The Hidden Value of People and Brand

#The Paper at a Glance

Title: Organization capital and the cross-section of expected returns

Authors: Andrea L. Eisfeldt and Dimitris Papanikolaou

Published: Journal of Finance, 2013

DOI: 10.1111/jofi.12034

In the 21st century, a company's most valuable asset isn't its building—it's its people, code, and customer loyalty. Yet, Generally Accepted Accounting Principles (GAAP) ignore these assets completely.

Eisfeldt and Papanikolaou developed a method to measure this Organization Capital (OC) and found that it is a massive predictor of future stock performance.

#Measuring the Invisible

Since OC isn't on the balance sheet, the authors estimated it by accumulating Selling, General, and Administrative (SG&A) expenses.

Using the "perpetual inventory method," they treated SG&A not as a cost, but as an investment that depreciates over time. - Are you spending on training? That's an asset. - Are you spending on marketing? That's brand equity. - Are you spending on consulting? That's process improvement.

The Findings

Firms ranked in the top quintile of Organization Capital outperformed those in the bottom quintile by 4.6% per year (risk-adjusted).

#Why Does OC Pay a Premium?

Unlike a machine, Organization Capital can walk out the door.

If your star engineers leave for Google, or your best salespeople join a competitor, your Organization Capital evaporates. This is called "Alienability Risk."

Because shareholders bear this risk (the risk of talent flight), they demand a higher return for holding high-OC companies. It's a risk premium for the "human factor."

#The Tech & Service Economy

This paper is crucial for understanding modern markets. - Old Economy: Value = Book Value (Price-to-Book works). - New Economy: Value = Book Value + Organization Capital.

If you rely on traditional metrics, you will structurally underweight Tech, Healthcare, and Services, because their "assets" are invisible.

#How This Applies to Our Rankings

This research supports our Intangible-Adjusted Value factor (part of our 15% Value weight).

We don't just look at reported Book Value. We adjust the "B" in P/B to include capitalized estimates of: 1. R&D (Knowledge Capital) 2. SG&A (Organization Capital)

This allows us to fairly evaluate companies like Microsoft or Visa, which look "expensive" on traditional metrics but are actually "fairly priced" when you count their massive Organization Capital.

See value stocks with high intangible quality →

#Academic Source

Eisfeldt, A. L., & Papanikolaou, D. (2013). "Organization capital and the cross-section of expected returns." Journal of Finance, 68(4), 1365-1406.