Measuring Wealth Generation in Early-Stage Entrepreneurial Organizations: An Alternative to the Capital Asset Pricing Model
Fiore, Robert A., Lussier, Robert N., Journal of Small Business Strategy
There is no generally accepted measure of wealth created by new ventures, as most early-stage firms do not have positive cash flows, and early-stage discount rates cannot be estimated with sufficient accuracy as required by the Capital Asset Pricing Model (CAPM). Through regression analysis of organizational economic value, as assessed by a sample of 145 CPAs, this research supports using a new economic evaluation methodology involving the use of early-stage organizational structure itself as a construct and predictor of economic value. The current research employs a Validated Nascent Organizational Structure Sequence (VNOSS) model as an alternative to CAP-M in establishing the perceived economic value of early-stage entrepreneurial firms. The small business owner that utilizes the strategy of taking the firm through the VNOSS stages will create greater economic wealth. There is a substantial discussion and implications of the applied research results.
Keywords: wealth, organization structure sequence, capital asset pricing model (CAP-M)
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Nominally, entrepreneurs start business ventures to generate economic wealth. To adequately study wealth creation, it must first be measured. The Capital Asset Pricing Model (CAP-M) is commonly used to estimate the economic value of assets that produce positive cash flow. Although expected cash flow and computed discount rates can be used, serious doubt exists that a CAP-M valuation of very new firms is sufficiently accurate because of the margin of error found in prospective cash flow estimation and the fact that CAP-M mathematics are extremely sensitive to the accuracy of inputs (Smith & Smith, 2000). More importantly, there is no accepted method to produce an accurate discount rate, as required by CAP-M. Hence, two key questions are:
* How can nascent firms be valuated without using cash flow or discount rates?
* What are the characteristics of economic growth as these firms grow and in what period of growth are the rates of return on invested capital generally highest?
Such questions and answers are pertinent to entrepreneurial small business owners and managers, their investors (banks, angels, and venture capitalists), small business educators, and consultants interested in new venture wealth creation.
It is hypothesized that the value of organizational structure in response to market opportunity and the ability of the venture group to build structure to exploit opportunity is a measure of success. The change in organizational structure is created through, and contributes to, successful growth. Thus, the very structure of the organization- and growth in that structure-may itself be a predictor or indicator of firm value. This exploratory study examines the Validated Nascent Organizational Structure Sequence (VNOSS) developed by Fiore and Lussier (2007), an early-stage organizational structure model that describes how the value of a successful venture rises together with the complexity of the venture's organizational structure. Within the current study, the VNOSS is proposed as an alternative to CAP-M in establishing the perceived economic value in entrepreneurial firms as the venture group exploits market growth opportunities.
Entrepreneurs and financiers want to know their chances of successfully creating wealth, and there is a need for better measures (Lussier & Pfeifer, 2000). Minniti and Bygrave (2001) stated that "Our entrepreneur wishes to maximize the subjective expected discounted value from his choices consistently with his intent" (p. 29). Deeds, DeCarolis, and Coombs (1998) stated that "market value added is a particularly appropriate measure of entrepreneurial performance because of its focus on wealth creation, which is the essence of entrepreneurship; the generally accepted accounting principles (GAAP) are inadequate measures of entrepreneurial effectiveness, as it is apparent that accounting-based measures of performance fail to accurately reflect the amount of shareholder wealth being created by the firm" (p. …