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

Abstract

This paper provides a different way of thinking about, and dealing with, four important issues. First, the overarching purpose of a firm involves communicating a vision, organizing to survive and prosper, working continually to develop win-win relationships, and taking care of future generations. Maximizing shareholder value is then positioned not as the purpose of the firm, but as the result of a firm achieving its purpose. Second, managements and boards need a valuation model that provides a clear and insightful connection between long-term corporate performance and market valuation. A strong case is presented for the life-cycle valuation model, widely used by money management organizations, in which a firm'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 with a life-cycle track record for 3M, 1960 to 2014. Third, an alternative to the accounting approach of capitalization and amortization of intangibles is a valuation approach that puts the future benefits from intangibles into more favorable forecasts of long-term fade rates. Fourth, incorporating Life-cycle Reviews for each of a firm's business units as part of its integrated report 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.

Keywords: Purpose, Maximizing Shareholder Value, Valuation Model, Life Cycle, Intangibles, CFROI

JEL Classification: D21, G10, G12, G30, G34, G38, L21, M10, M41