Corporate Finance and Strategic Planning: A Linkage

This chapter takes a first step toward closing the gap between traditional corporate finance theory and strategic planning. To put issues in a broad perspective, figure 1.1 summarizes three approaches to strategic planning and their impact on the market value of the firm. This conceptual framework aligns the design of an investment strategy with the value of the firm. Consider the various sources of economic or market value a firm can create. As shown in the left-hand column, the market value of a firm is not completely captured by the expected cash flow generated by the tangible assets that are currently in place (measured by NPV). Stock market prices partly reflect a firm’s strategic growth potential. This value derives from investment opportunities that the firm may undertake in the future under the right circumstances, and is sensitive to competitive moves. The strategic option value of a firm can be vulnerable not just to the actions of incumbents, but also to the unanticipated entry of new rivals with entirely new technologies that can modify the competitive landscape in which the firm operates. Investment appraisal methods should capture the components of flexibility and strategic value, as they may contribute significantly to the firm’s market value in an uncertain competitive environment. The flexibility and strategic considerations of importance to practicing managers can now be brought into a rigorous analysis in a fashion consistent with the tenets of modern finance and the maximization of shareholder value. The righthand column in figure 1.1 shows the valuation approach based on insights from real options and game theory, which captures additional flexibility and strategic value not measured by cash flow benefits per se. This approach considers growth opportunities to be a package of corporate real options that is actively managed by the firm and may be affected by competitors actions and by new technologies. If a firm’s investment decisions are contingent upon and sensitive to competitors’ moves, a game-theoretic © Copyright, Princeton University Press. No part of this book may be distributed, posted, or reproduced in any form by digital or mechanical means without prior written permission of the publisher.