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Investment, valuation, and the managerial theory of the firm.

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posted on 19.11.2015, 09:01 by A. J. Baker
Common to both parts of this study is an acceptance of management's discretionary behaviour in product markets, comparative security against takeover, self-financing potential and interest in defining a top level of strategy choice. The study first explores the "managerial" content of orthodox valuation and cost of capital theory, then modifies that theory to represent management's framework for strategy choice under realistic conditions. Part I develops the orthodox valuation and cost of capital theory applicable to "safe" investments. Management's continuing objective is the constrained maximisation of equity investors' wealth: dividend risk policy --- not minimisation of the cost of capital --- takes priority, and the constancy of cost of capital is only achieved through continuous control over investment financing aimed at maintaining the target level of dividend risk. In Part II investment profitability is assumed subject to ex ante risk, and this necessitates a further retreat from a market-determined investment criterion. Given management's (largely) discretionary criteria for investment --- its investment strategy --- performance through time is generated by repeated interactions of probabilistic investment demand and profitability functions, and can be described ex ante in terms of a probability distribution of growth-paths of earnings and investment. With appropriate conditional planning of investment financing, management can picture any strategy as a probability distribution of growth-paths of constant-risk dividend expectations. A minimal extension of the orthodox valuation model yields an interpretation of share valuation under multiple growth-path conditions and allows management to identify the equity value prospects of alternative strategies. The resulting model of decision making and managerial utility permits a full range of realistically interpreted motivations --- from investor-oriented to "mangerial" --- and contrasts strongly with certain implications of models depicting strategy choice in terms of a choice between steady-state growth-paths.


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University of Leicester

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