What managers get wrong about capital / Roger L. Martin

Why do large corporations sell off business units to PE firms that make a fortune by selling them a few years later? The author, a former Rotman School dean, argues that the answer is rooted in the way many corporations value their businesses and projects. Their basic mistake is to compare estimates of future cash flow with the amount of cash put into a business as a capital investment. Although this sounds perfectly reasonable (and largely follows conventional practices for measuring economic value added, or EVA, and its equivalents), it can anchor performance measurement in a historical number that very quickly loses its relevance. As Martin explains, once an investment has been made in an asset, the company’s expectations about the value that investment will create are, in effect, publicized. Thus a company assessing the performance of its investment should base its measures not on the cash put in but on the current value of the asset or capability in question, which—and this is the critical point—includes the value that the market already believes the company will create or destroy with that asset or capability. Martin describes an approach that is grounded in market expectations about future value.

Business.