Non-Financial Goals and “Irrational” Decision-Making Behaviors:
Enhancing the Calculation of Private, Family Firm Value
Jeremy A. Woods, Doctoral Student
Department of Management, College of Business, University of Cincinnati
Overview
Many scholars have questioned the practical
relevance of the business valuation models of
neoclassical economics and agency theory-based
business strategy in a world where many private,
family owned and managed organizations
(Astrachan & Shanker, 2003; Birch, 1979) fall
beyond the limited boundaries of these models’
assumptions.
Over the past three decades, family business
scholars (Astrachan & Jaskiewicz, 2008),
organizational psychologists (Staw, 1976, 1981;
Staw & Ross, 1978, 1987), and behavioral
economists (Kahneman & Tversky, 1979) have
developed a number of empirically rigorous
methods for measuring human decision-making
behavior in private, entrepreneurial organizations.
This paper proposes a hybrid equation for the
calculation of firm financial value using constructs
intended to capture the value of non-financial goals
and “irrational” decision-making behaviors (i.e.,
behaviors which do not follow classic, prospective
utility maximization functions).
Emotional Value
The equation presented here is inspired by a
construct developed by Astrachan and Jaskiewicz
(2008), emotional value (EV).
Emotional value consists of emotional returns (ER
= positive emotional benefits which come from
owning and running a private business, such as
sense of pride and accomplishment, flexible work
hours and responsibilities, or the pleasure of
working together with family members) and
emotional costs (EC = negative emotional
liabilities which come from owning and running a
private business, such as stress from the
entrepreneurial assumption of risk, reduced total
leisure time, and professional-personal relationship
conflicts with family members).
Astrachan and Jaskiewicz integrate the abovementioned definitions with the more familiar
economic constructs of discounted cash flows (DCF
= the net present value of expected future cash
flows, or the expected equity value of the firm) and
discounted financial private benefits (DFPB = the
net present value of expected non-equity benefits
such as salary and perks not captured in the equity
value of the firm) to come up with the following
formula for total firm value (TV):
TV = DCF + DFPB + (ER – EC) [1]
This paper adds two additional elements to the
equation above.
Self-Justification
The first additional element is based on Staw and
Ross’ (1978) concept of escalation of commitment,
in which individuals sometimes make decisions
based on retrospective, rather than prospective,
maximization of the non-financial goal of selfjustification.
This concept is consistent with the basic idea of the
Astrachan and Jaskiewicz model, which is that both
financial and non-financial value must be
considered when calculating the total value of
privately held, entrepreneurial businesses.
The escalation of commitment phenomenon can be
seen as one particular way in which non-financial
goals can become built into the value of the firm
over time.
The non-financial value of self-justification (SJ =
the purely emotional value of justifying prior
personal decisions by continuing to follow a certain
course of action, which this paper will define as the
difference between the prospective future utility of
the most profitable course of action for the business
minus the prospective future utility of the course of
action being followed by the business, with DCF,
DFPB, ER, and EC otherwise being held equal)
could be added to equation [1] above as follows:
TV = DCF + DFPB + (ER + SJ – EC)
Equation [3] above should represent an expansion
of existing constructs to allow for more accurate
valuation of private, entrepreneurial businesses.
This increased accuracy is reflected in the following
propositions:
[2]
Risk Comfort
The second additional element to be integrated into
the equation above is based on Kahneman and
Tversky’s (1979) prospect theory, in which human
beings tend to misestimate prospective future
financial utility depending on the risk context within
which they perceive their decision options.
Similarly to escalation of commitment, prospect
theory is also a useful concept for the calculation of
the non-financial value of a private, entrepreneurial
firm. Kahneman and Tversky’s experiments tended
to show that individuals favor a smaller benefit with
certainty over the chance of a larger benefit and
favor the possibility of the complete avoidance of
large negative consequences over the certainty of
experiencing mild negative consequences.
This behavioral tendency can be seen as the
pursuit of a non-financial goal which one might call
“risk comfort”, which for the purposes of this paper
shall be defined as a preference for certainty of
benefits (however modest) and the avoidance of
losses (whatever the risk).
The non-financial value of risk comfort (RC = the
preference of an individual decision maker for small
positive benefits and avoidance of negative
consequences, which this paper will define as the
difference between the decision maker’s preference
for a given decision option and the actual
prospective future utility of that decision option, with
DCF, DFPB, ER, SJ, and EC otherwise being held
equal) could be added to equation [2] above as
follows:
TV = DCF + DFPB + (ER + SJ – RC – EC)
Propositions
[3]
Proposition 1: Family business owners who derive
emotional returns from their businesses will value
their businesses higher than objective third parties.
Proposition 2: Family business owners who derive
emotional costs from their businesses will value
their businesses lower than objective third parties.
Proposition 3: Family business owners who place a
financial value on self-justification will value their
businesses higher than objective third parties.
Proposition 4: Family business owners who frame
the valuation of their businesses in terms of current
revenue streams, rather than potential future
revenue streams, will value their businesses lower
than objective third parties.
Next Steps
To test the above-outlined propositions, this paper
proposes to conduct survey research with a sample
of family business owners from various countries
around the world.
The survey questions will measure emotional
returns, emotional costs, self-justification, and risk
comfort.. The survey will also capture information
about these business owners’ valuations of their
own businesses, which will be compared to
objective third party assessments of the business’
values.