“In Value Creation Principles, Madden introduces the pragmatic theory of the firm that positions the firm as a system fueled by human capital, innovation, and, at a deeper level, imagination. He challenges us to understand how we know what we think we know in order to better discover faulty assumptions that often are camouflaged by language. His knowledge building loop offers guideposts to design experiments and organize feedback to facilitate early adaptation to a changed environment and to avoid being mired in ways of thinking rooted in ‘knowledge’ of what worked well in the past—a context far different from the context of today. His book explains a way of being that enables those who work for, or invest in, business firms to see beyond accounting silos and short-term quarterly earnings and to focus on capabilities instrumental for creating long-term future and sustainable value for the firm's stakeholders. I can't recommend this astounding book enough especially given its deep and timely insights for our world today.”
—John Seely Brown, former Chief Scientist for Xerox Corp and Director of its Palo Alto Research Center (PARC); co-author with Ann Pendleton-Jullian of Design Unbound: Designing for Emergence in a White Water World
“In contrast to existing abstract theories of the firm, Madden's pragmatic theory of the firm connects management's decisions in a practical way to a firm's life cycle and market valuation. The book promotes a firm's knowledge building proficiency, relative to competitors, as the fundamental driver of a firm's long-term performance, which leads to insights about organizational capabilities, intangible assets, and excess shareholder returns. Value Creation Principles is ideally suited to facilitate progress in the New Economy by opening up the process by which firms build knowledge and create value, which is a needed step in revising how neoclassical economics treats the firm.”
—Tyler Cowen, Professor of Economics, George Mason University; co-author of the popular economics blog Marginal Revolution
“Bartley Madden rightfully points out that both textbook and more advanced economic theories of the firm fail to address the concerns of top management and boards of directors. He offers a tantalizing pragmatic alternative that directly connects to quantitative changes in the firm's market value. His framework gives recognition to the importance of intangible assets, and his pragmatic approach is quite complementary to the Dynamic Capabilities framework that strategic managers implicitly and sometimes explicitly employ.”
—David J. Teece, Thomas W. Tusher Professor in Global Business, Faculty Director, Tusher Center for the Management of Intellectual Capital, Haas School of Business, University of California, Berkeley
“Drawing upon a long history of experience and research, Madden integrates management theory and firm valuation in Value Creation Principles. He hypothesizes the foundational importance of managerial processes to sustain knowledge building proficiency and demonstrates its relevance through case studies of important firms. Absent a culture of purpose, respect, experimentation, and learning, innovative processes degrade and hinder firm competitiveness. He convincingly deviates from traditional accounting standards and bedazzling quantitative methods in developing the pragmatic theory of the firm that is well suited to the New Economy's reliance on intangible assets and human capital. Underlying the entire exposition is Madden's clear understanding of market-oriented choice and the limitations of rigid hierarchies and bureaucracies, particularly in the complex systems that we call ‘firms.’”
—Brian Singer, CFA, Partner, William Blair, Dynamic Allocation Strategies and former chairman of the CFA Institute
“In Value Creation Principles, Madden applies a holistic, systematic view of the firm to connect finance to the broader issues of managing firms through the creation of intangible assets. He provides a life-cycle lens that reveals the economic logic that drives levels and changes in stock prices over the long term. Management priorities need to be attuned to a firm's life-cycle position. He explains excess shareholder returns at a much deeper level compared to the popular factor studies in finance, while offering a blueprint for future research. The key to excess returns is shown to be intangible assets, and especially unique brands, that favorably contribute to a firm's long-term, competitive fade of profitability. The book should be read by anyone concerned with expanding the contribution of finance to business.”
—Bobby J. Calder, Kelstadt Emeritus Professor of Marketing, Kellogg School of Management, Northwestern University
“Bart Madden has written an important book rooted in systems thinking. Understanding a systems approach to value creation by business firms is at the heart of his Pragmatic Theory of the Firm—a theory that is focused on the practical tasks of knowledge building and value creation. An important insight from this book is the ongoing and dynamic connection between a firm's knowledge building proficiency, long-term competitive fade of a firm's profitability, excess shareholder returns, and the concept of firm risk that differs from CAPM's investor risk. Firm risk, in Madden's words, is about obstacles that interfere with achieving the firm's purpose, which includes broad stakeholder advancement. Value Creation Principles provides insightful guideposts for managements, boards, and investors, as well as providing new thinking on academic research regarding the purpose of the firm.”
—David R. Koenig, author of Governance Reimagined: Organizational Design, Risk and Value Creation and The Board Member's Guide to Risk
“Value Creation Principles takes a holistic approach to how firms create value and maintain a competitive advantage. Knowledge building, systems thinking, and a strong sense of purpose hold the key. Bartley Madden's wide-ranging command of the evolution of the theory of the firm leads to an inevitable conclusion: knowledge building proficiency rooted in sustainable capitalism leads to progress for the firm and for the economy.”
—Michele Wucker, bestselling author of The Grey Rhino: How to Recognize and Act on the Obvious Dangers We Ignore
Copyright © 2020 by the Bartley J. Madden Foundation. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data
Names: Madden, Bartley J., author.
Title: Value creation principles : the pragmatic theory of the firm begins with purpose and ends with sustainable capitalism / Bartley J. Madden.
Description: First Edition. | Hoboken : Wiley, 2020. | Includes bibliographical references and index.
Identifiers: LCCN 2020006300 (print) | LCCN 2020006301 (ebook) | ISBN 9781119706625 (cloth) | ISBN 9781119706632 (adobe pdf) | ISBN 9781119706649 (epub)
Subjects: LCSH: Organizational effectiveness. | Organizational learning. | Production management. | Value.
Classification: LCC HD58.9 .M343 2020 (print) | LCC HD58.9 (ebook) | DDC 658.15/52—dc23
LC record available at https://lccn.loc.gov/2020006300
LC ebook record available at https://lccn.loc.gov/2020006301
Cover Design: Wiley
Cover Image: © sakkmesterke/Getty Images
In memory of my business partners who shared an exciting intellectual journey with me:
Charles G. Callard, Robert E. Hendricks, and Rawley Thomas.
I strongly believe that a firm's long-term performance is a direct result of its knowledge-building proficiency. That belief is the result of my work in two research areas that normally are not connected—finance and knowledge building. First, by way of background, my career in finance began with the startup of the boutique research firm Callard Madden & Associates in 1969. Our primary mission was to understand levels and changes in stock prices worldwide and provide practical insights to enable portfolio managers to make better investment decisions. We devoted considerable effort analyzing management decision-making in the context of a firm's long-term financial performance quantified as life-cycle track records. Over many years I have been fortunate to work with talented colleagues at Callard Madden and later at HOLT Value Associates. Our research addressed a never-ending stream of problems in connecting a firm's accounting-based performance to its market valuation.
While this finance work was progressing, I got hooked on a second research area dealing with how we know what we think we know, which remains my ongoing intellectual passion.1 The more I learned about the knowledge-building process, the clearer it became that knowledge building and value creation are opposite sides of the same coin. The more I analyzed management tasks such as strategy, innovation, employee engagement, development of new capabilities, etc., the more I realized that the root cause of a firm's long-term performance and returns to its shareholders is the firm's knowledge-building proficiency relative to competitors. This book makes what I believe is a strong case that a new holistic theory of the firm, built upon this foundational importance of a firm's knowledge-building proficiency, will improve thinking about the role of firms in society. Moreover, this new theory of the firm is labeled “pragmatic” because it facilitates systems thinking to analyze practical problems thereby leading to improved decision-making for managements, boards, and investors.
Theories of the firm tend to be narrow in scope and ignore how firm performance connects to market valuation. A notable advantage of the pragmatic theory is its explanation of what drives a firm's long-term financial performance and its returns to shareholders. The more one understands long-term stock prices, the better one appreciates the mutual interests of shareholders and other stakeholders.
As to understanding levels and changes in market valuations, my early research at Callard Madden was instrumental in developing the CFROI (cash flow return on investment) valuation model and related global database.2 The CFROI research program is rooted in economically sound principles applied to the construction of long-term, life-cycle track records of a firm's financial performance; the forecasting of a firm's long-term net cash receipts; the calculation of warranted market valuations; and the decoding of investor expectations implied in stock prices. This unique research program was further advanced by HOLT Value Associates, which was acquired by Credit Suisse in 2002. A highly skilled team at Credit Suisse HOLT continues to advance the CFROI valuation framework as part of the Credit Suisse HOLT global database, which is used worldwide by many large money management organizations.
The seven chapters in the book can be distilled into the following fourteen key ideas:
In conclusion, I was fortunate to have two friends volunteer to extensively edit the entire manuscript. As to writing, both are perfectionists. Jack Reardon is the author of economics textbooks and the founding editor of the International Journal of Pluralism and Economics Education. Bryant Matthews is Global Director, Credit Suisse HOLT Research and the coauthor of Beyond Earnings: Applying the HOLT CFROI and Economic Profit Framework. Others at Credit Suisse have helped me on my journey: Jim Ostry, co-Head and Managing Director of Credit Suisse HOLT; Tom Hillman, Managing Director and head of HOLT's research team; and Rick Faery, Global Head of Corporate Insights Group, Credit Suisse Investment Banking. Especially useful comments were provided by Joe Cursio, Jerry Ellig, Maureen Ryan Healy, Keith Howe, Tom Malatesta, Jeff Ubois, and my sons, Greg Madden and Jeff Madden. I am grateful to Mark Frigo, who frequently invited me to present many of the ideas in this book to his MBA students at DePaul University. I appreciate the graphic design skills of Kimberly and Johnny Allgaeuer, who produced the book's many figures.
Finally, I am on the Executive Advisory Board of the Center for Advancing Corporate Performance (CACP) started at the Illinois Institute of Technology. I am working with Mark Ubelhart, David Koenig, and others to make CACP a world-class organization in providing practical insights about value creation for broad stakeholder groups using the business firm as the fundamental unit of analysis.