Decomposing Firm Value

Abstract

What are the economic determinants of a firm's market value? We answer this question through the lens of a generalized neoclassical model of investment with physical capital, quasi-fixed labor, and two types of intangible capital, knowledge and brand capital. We estimate the structural model using firm-level data on U.S. publicly traded firms and use the estimated parameter values to infer the contribution of each input for explaining firm's market value in the last four decades. The model performs well in explaining both cross-sectional and time-series variation in firm's market values across industries, with a time-series R2 of up to 61%, and a cross-sectional R2 of up to 95%. The relative importance of each input for firm value varies across industries and over time. On average, physical capital accounts for 30% to 40% of firm's market value, installed labor force accounts for 14% to 22%, knowledge capital accounts for 20% to 43%, and brand capital accounts for 6% to 25%. The importance of physical capital for firm value decreased in the last decades, while the importance of knowledge capital increased, especially in high-tech industries. Our analysis provides direct empirical evidence for the importance of labor and intangible capital inputs for understanding firm value.

Keywords: Valuation, Neoclassical Investment, Structural Estimation, Intangibles

JEL Classification: D21, D22, E22, E24, G12, G32