What do you know?

That's becoming the question of the hour as managers gear up to compete in our global, real-time, information-- hungry economy. Knowledge assets-those intangibles such as R&D and employees' expertise-increasingly drive companies' bottom lines and stock prices.

Unfortunately, when it comes to calculating just how much knowledge assets contribute to results, the tools at hand are closer to the Dark Ages than the New Millennium. That's because the accounting system is designed to capture such physical assets as buildings and machinery. It isn't so great at measuring how much activities such as investing in a company's brand name boost (or maybe don't boost) earnings.

Yet, "If the knowledge economy will consist of knowledge-based businesses and if that means that we have to run businesses by optimizing their knowledge assets, then we'd better find ways to make them visible and develop ways to describe the state of the knowledge assets," says Dan Holtshouse, director of corporate business strategy at Xerox Corp., Stamford, Conn., and leader of its knowledge-management efforts.

Baruch Lev, professor of accounting and finance at New York University, has taken on the challenge. Assisted by Marc Bothwell, portfolio manager at Credit Suisse Asset Management, New York, Lev created the Knowledge Capital Scorecard, a measurement tool to which Lev holds trademark rights and which was reported on in CFO magazine this year.

Lev begins with a surprisingly encompassing definition of knowledge assets. "Everything that contributes to profitability [and] that isn't a physical or financial asset," he says, is a knowledge asset. In other words, earnings that can't be traced to physical and financial assets must come from knowledge assets.

The scorecard calculations deliberately employ "normalized" earnings-specifically a combination of the average actual annual earnings for the firms being studied for the three years ending in 1997 plus stock analysts' forecasts of earnings for three years into the future.

The formula's actual math is pretty straightforward. First, the earnings generated by a firm's physical and financial assets are subtracted from annual earnings. (Lev and Bothwell assumed that physical assets produce an after-tax return of 7% and financial assets a 4.5% after-tax rate of return.) Then, to arrive at a figure for knowledge capital, the remaining earnings are divided by a knowledge discount rate of 10.5% (a number that comes from research studies, says Bothwell).

Lev and Bothwell have applied the knowledge-- capital formula to a number of companies in the chemical and pharmaceutical industries-and have uncovered some critical differences. For example, the pharmaceutical companies had an average level of knowledge capital of $10.7 billion, while the chemical companies averaged $2.8 billion-less than one-third the level of the pharmaceutical firms. The reason, says Bothwell, is the generally higher level of R&D investment (a knowledge asset) that goes on at pharmaceutical firms. And that difference, they say, helps explain the typically higher stockprice valuations of pharmaceutical companies. Lev and Bothwell stress that all companies-not just high-tech or knowledge organizations-need to measure knowledge assets.

To be sure, the Lev scorecard is a first cut at the elusive goal of assessing knowledge assets and putting a value on them. And the scorecard in its current incarnation leaves some questions unanswered. Indeed, Lev says his next step is to come up with ways to measure how much each of the drivers of knowledge capital, such as R&D and brand management, contribute to results. Then managers can better decide how to divvy up resources among competing uses.

Still, managers recognize the potential payoff and are expressing interest. "If we can understand how to make visible and measure the flow of knowledge to within even 1% of what we do with the movement of money, we could effect incredible change," says Xerox' Holtshouse.