Part 3

The Holy Grail of business valuation demands a full accounting of the positive and negative vectors associated with all value drivers.

Once we look at a firm as the sum of its value drivers, we have in effect a new theory of the firm. We will no longer consider a firm only in microeconomic terms, as an intersection of cost of production with the meeting point of supply and demand curves in a market responding only to the utility curves of self-centered, rational-choice theory. That model of a firm is too close to a one-time sale to be of much help in assessing the firm's capacity for sustainable profitability. A firm must be more than a transaction; in a transaction, you can take the money and run giving little or no concern to the future consequences of the negative externalities arising from one's conduct. A firm - if it is to have capital value - must stay in business over repeated cycles of production and sales. A firm is a series of transactions, happening one after another over time. Only the cumulative returns of many sales give capital value to a firm.

The better way, therefore, to envision a firm is to see the business as a (hopefully) never-ending circular flow of capital mobilized for production of goods and services sold to customers for a profit which is then used as a return on the various forms of capital used in production. The business must make enough profits to ensure that it can pay enough for its forms of capital to ensure the continual supply of capital and other inputs.

The successful enterprise is a revolving process, not a one-way journey seeking only the payout of ownership interests. Any robust theory of the firm must reflect this dynamic of continuous profitability.

A theory of the firm divorced from the measurement of results would provide little help in managing an enterprise. Unfortunately, traditional accounting conventions and categories do not embrace the full range of value drivers implicit in a robust theory of the firm.

New ways of recording and reporting relevant data are needed to make a conceptual Holy Grail of business valuation really useful to managers and investors.

What needs to be recorded is data bearing upon the positive or negative tendencies of the various value drivers supporting a firm's sustainable profitability, and the capital value derived from the size and quality of that income stream. Intangibles as well as traditional tangible financial metrics need to be included; some external variables need to be estimated objectively as well.

If one thinks of the sustainable profitability of a firm as a function of its "quality," then lessons can be drawn from the quality movement of the 1980's and the work of W. Edwards Deming for the design of more comprehensive metrics for measuring the Holy Grail of business valuation. The quality movement looked to external subjective conditions such as levels of customer satisfaction and to statistics on production results to design management standards and benchmarks to improve the quality of output. In the United States, the Malcolm Baldrige Award developed a philosophy of inquiry to create a scoring system of management results not dependent on traditional accounting concepts and conventions. The Baldrige Award process asks first if a company has taken an "approach" to quality. Second, the company is graded on the extent to which it has "deployed" management goals to implement that approach. Third, the company is scored on the results it has achieved in meeting the goals set forth in its "deployment" strategy. This overall approach to the assessment of a company's position vis-a-vis a key value driver like quality of product can be extended to other value drivers as well. A pro-forma comprehensive assessment of a firm's situation vis-a-vis all its key value drivers has been developed by the Caux Round Table. We consider this a self-assessment and improvement process to provide owners and managers with the data necessary to shape strategic decisions impacting value drivers in a positive manner.

Integrating virtue and self-interest at the level of the firm is possible. Through management decision-making, capitalism can internalize concern for the public welfare without sacrificing the efficient rationality of seeking profitability. Such a form of capitalism can be a more moral one, less deserving of criticism on social justice grounds.