The Purpose of the Firm,Valuation, and the Management of Intangibles

This article provides a different way of thinking about, and responding to, four important issues that confront most public companies. First, in articulating the overarching corporate purpose, the author suggests a middle ground between shareholder value maximization and stakeholder theory that aims to achieve the end result of value maximization while taking a “holistic” view that meets most of the demands of stakeholder advocates. As described by the author, there are four critical steps for management and boards in creating such companies: (1) communicating a vision of the company and its purpose to employees as well as investors (and other key outsiders); (2) organizing to survive and prosper through efficiency and innovation; (3) working continuously to develop win‐win relationships with stakeholders and other companies; and (4) taking care of the environment and future generations. Second, in thinking about the corporate purpose and how to evaluate success in achieving it, managements and boards need a valuation model that provides a clear and insightful connection between long‐term corporate performance and market valuation, and how both might be expected to change as the firm matures. A strong case is presented for the life‐cycle valuation model, widely used by money management organizations, in which a company's projected cash flows reflect an expected “fade” in both economic returns on capital and reinvestment rates. The potential uses of this model are illustrated using lifecycle corporate performance data for 3M during the past 50 years. Third, in an effort to capture the value of innovation and investment in intangible assets, the author presents an alternative to the accounting approach of capitalizing and amortizing such assets that attempts to capture their expected future benefits by using more favorable forecasts of long‐term fade rates. Fourth, the author shows how incorporating Life‐cycle Reviews for each of a company's business units as part of its Integrated Reporting could improve management's resource allocation decisions, help build a shareholder base of long‐term investors, and provide management with the support and confidence to resist Wall Street's excessive emphasis on quarterly earnings.