Wealth Creation: A Systems Mindset for Building and Investing in Businesses for the Long Term (Wiley Finance) by Bartley J. Madden combines several concepts like systems theory, lean production, Deming’s Plan-Do-Check-Act learning cycle, key performance variables (metrics) and a valuation model with greater emphasis on the cost of capital (including human capital) into a “competitive life-cycle” view of the firm.
Companies that adopt Madden’s methodology may be able to overcome Schumpeter’s model of high innovation followed by competitive fade, maturity and eventual failure. Shareowners are more likely able to key in on valuation issues using a longer-term perspective and are likely to be less startled with earnings surprises.
Madden argues against “fair value” accounting, arguing that a measure of economic return should express what was received, against what was given up. That can’t be properly measured if the original cost outlays are unavailable but supplementary information on estimated market value would be a plus.
Although he recognizes the need to account for intangibles (especially around human capital), he provides little guidance in this area other than recommending that whatever definitions are utilized should be tagged using XBRL to enable fine-grained analysis. However, one slim volume can’t be faulted for not providing detailed guidance to every step in a recipe.
The book includes a helpful chapter on corporate governance where he calls most management arguments against greater shareowner involvement like their supposed short-termism “a smoke screen because the plain fact is that CEOs want to either hand-pick board members, or at least have veto power over nominees.”
One idea of Madden’s that deserves to catch fire is the “shareholder value review” (SVR), where boards demonstrate in the annual report how they are fulfilling their duty to shareowners to create wealth. Such reviews would include three key elements:
- A description of the valuation model used to connect the firm’s financial performance to its market value, plus a description of how the firm is organized and managed in order to nurture a performance-oriented culture.
- Value-relevant track records that chart the wealth-creation/dissipation performance for each of the firm’s major business units.
- A description of each business unit’s strategy and the related rationale for planned reinvestment or downsizing if the unit has no reasonable plan for well-above-cost-of-capital economic returns.
Again, Madden emphasizes use of XBRL in facilitating the ability of both directors and shareowners to be able to drill down through life-cycle track records to perform customized analysis. Shareowners have recently had some success in filing resolutions requesting that companies include various environmental reports in their annual reports. It would be interesting to see shareowner proposals seeking inclusion of SVRs and their eventual use by funds such as CalPERS in developing their focus lists of underperformers.