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Strateg.management - Essay Example

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The term "New Economy" emerged in the late 1990s when Internet-driven Information Technology replaced "old economy" players like automobiles, consumer products and heavy engineering products as the leading industries both in terms of revenue earnings as well as stock market valuation…
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Download file to see previous pages While in the first two waves, which gave birth to many of the old economy products, the innovation led to tangible goods that could be valued as could the enterprises that produced them. The third wave of IT revolution, however, the product was an intangible commodity - knowledge - that could be shared within and across organizations beyond boundaries. While the potential of the growth of these IT companies was deemed to be enormous, as was evident from the early signals of growth demonstrated by these companies, the stock markets in the USA and Europe reacted far more dramatically between 1990 and 2001. Since most of the owners of the new economy companies were young and first-generation entrepreneurs, there was no way to value the companies on the basis of their net worth. Most of these companies spent enormous amounts of capital, often funded by venture capital, on the hope of much faster growth of future earnings, which were inherently uncertain. As a result, there was a large dose of speculative investments in the stock markets, much of it from the household sector, and the speculative bubble crashed in 2001. In this paper, I will discuss the various aspects in which the valuation of the new economy companies were different from that of the old economy companies by the capital market, demonstrating a dual approach in its valuation process.
Intangible inputs and products
As Al Gore, Vice President of the United States said at the Microsoft Summit in 1997, "In the Old Economy, the value of a company was mostly in its hard assets - its buildings, machines and physical equipment. In the New Economy, the value of a company derives more from its intangibles - its human capital, intellectual capital, brainpower and heart. In a market economy, it's no surprise that markets themselves have begun to recognize the potent power of intangibles. It's one reason that net asset values of companies are so often well below their market capitalization" (quoted in Bond & Cummins, 2000). The above quote reflects the buoyant mood that policymakers saw the boom in the New Economy in late 1990s. The New Economy was expected to herald in a new growth trajectory on the basis of intangible assets of the company while the product as well was intangible. Hence, the stock markets valued the New Economy in a grossly different manner than it did the Old Economy. While the capital markets valued the Old Economy on the basis of the replacement cost of capital, as was the basis of the Tobin's Q model, the New Economy was valued on the basis of the intangible assets like human and intellectual capital (Bond & Cummins, 2000).
Valuation and Replacement cost of capital
In theory, the stock market is considered an efficient one when the stock prices reflect the fundamentals of the company accurately. That is, for an efficient stock market, the market value of a company is exactly equal to its fundamental value, defined as the expected present discount value of future payments to the shareholders (Bond & Cummins, 2000). From this, derives the Tobin's Q ratio, that is market valuation to the replacement cost of capital, the latter discounting market power and adjustment costs, which should be 1 for an efficient market. For an ...Download file to see next pagesRead More
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