I had the opportunity to present research on Discounted Cash Flow (DCF) conducted as part of PERFORMABUSINESS at the Annual Meeting of the Society for Social Studies of Science (4S) that was held on October 9-12 in San Diego, California. I talked about DCF and drug development (“What’s a molecule worth? Discounted cash flows and drug development”), drawing on a paper presented last month at the Congress of the French Sociological Association. My talk was part of a session on “Calculability and performativity” which explored processes of making things calculable through case studies in natural resource management, corporate social responsibility, risk modeling, and drug development. Kathrine Tveiterås from the University of Tromsø showed how marine systems are economized to be made manageable, through the 2009 Norwegian Marine Resources Act which broadened the scope of regulation from commercially interesting stocks to include all living marine resources. Laure Cabantous from Cass Business School discussed how the implementation of new European insurance regulation (Solvency II) induced changes in risk management practices in insurance companies. Jean-Pascal Gond from Cass Business School described the construction of the French responsible investment market, highlighting the role of calculative infrastructure and uncertainty displacement. The discussions, opened by Peter Karnøe’s comments on truthfulness, contestations and dynamics in processes of calculability and performativity, raised issues relating to the interplay between tool-supported calculations and professional judgment, the different forms and roles of uncertainty, and the effects of responsible investment practices.

From my paper’s abstract:

Research and development of new drugs increasingly relies on partnerships between pharmaceutical companies and biotech start-ups. The latter are, in most cases, new ventures founded to commercialize results originating from public research. While the ability of biotech start-ups to translate scientific knowledge into knowledge that “the market will value” has been emphasized in the literature, little is known about this valuation process in practice. The paper examines how the market value of scientific knowledge is demonstrated and measured in partnerships between pharmaceutical companies and biotech start-ups, by focusing on a calculative device that is central in this process: the discounted cash flow formula (DCF).

DCF calculates the value of a project by estimating the future cash flows that this project is likely to generate, reducing them by a certain factor due to their distance in time and their probability to occur, and adding them up to obtain the project’s “present value”. Faced with drug development projects, and their considerable length and uncertainty, the formula produces puzzling results: seemingly strategic projects turn out to have insignificant, or even negative, value. In order to account for the widespread use of a seemingly false, or even dangerous, formula, the paper adopts a performative approach and examines the effects that DCF induces in practice. Building on interviews with managers and consultants involved in project valuation, as well as on the analysis of scholarly and practitioner publications, we highlight two “felicity conditions” for the formula’s performativity, which pertain to its network and its affordances.

The discounted cash flow formula (DCF) is of major interest for the social inquiry of capitalization into which the PERFORMABUSINESS team has proposed to delve. Since the 1950s, DCF has become the key tool that equips practices of economic valuation, aids firms and governments in their investment decisions, orients the allocation of resources, and shapes the management of projects. DCF carries a peculiar theory of valuation. It derives the value of a thing from the cash flows (revenues and expenses) that this thing is expected to generate in the future. It also reduces these flows by means of a discount rate, which reflects the idea that the future is worth less than the present, and that uncertainty is worth less than certainty. By doing so, DCF grants greater value to projects whose returns are proximate and predictable. As a consequence, DCF has been blamed to systematically undervalue innovative projects and hence impede their pursuit. Some have further argued that the formula actually misrepresents managers’ practices by failing to take into account the flexibility and learning they are capable of. Others have even suggested that the use of DCF is responsible for managers’ focus on short-term returns and their unwillingness to undertake the kinds of projects that help the organizations — and nations — to which they belong survive and prosper in the long run.

Since the 1980s, a few scholars in corporate finance, economics, strategy, and engineering have proposed to address such criticism by replacing DCF with another approach. Inspired by advances in financial theory (namely the work of Fisher Black, Myron Scholes and Robert Merton), they have attempted to extend options reasoning to the world of “real” (i.e., non-financial) assets and investment decisions within firms. The idea was to envisage an investment made by a firm (e.g., purchasing a lease for coal land, spending in research and development, building a new factory) as an option, in so far as it gives the firm the right, but not the obligation, to take action (mine coal, market a new technology, expand production) at a later stage. This view had two advantages. First, if an innovation project could be thought of as an option, its value would become greater than what DCF would compute — because the capacity of management to adapt and take optimal decisions becomes part of the equation. And, second, the value of the project could be calculated thanks to the tools that had been recently developed for the purpose of pricing of financial options.

In the 1990s, the real options approach sprinkled enthusiasm among scholars, consultants and a few practitioners. But it also raised numerous questions. To what extent can a formula be transposed from the world of financial markets to that of corporate investment decisions? Doesn’t it require too big changes in the ways firms are structured and projects are managed? Isn’t it too complex for users other than MIT-trained financial officers? Do its assumptions — namely, that managers are flexible and capable to make and exercise optimal decisions — eventually hold true?…

We believe that the controversies around DCF and real options provide us with an insightful viewpoint on the performativity of valuation formulas, that is, the worlds that they require building in order to function and the effects that they induce when put in practice. The PERFORMABUSINESS team has hence engaged in an analysis of these controversies. Our methodology relies on two sources of data. First, we are carrying out interviews with academics and practitioners who have been involved in the development of real options. Second, we are conducting a quantitative study of the literature on real options, experimenting with a novel approach which should enable us to account for relations not only between publications (by following citations and hyperlinks for example) but also within them (by looking for the entities that publications figure, and the ways in which they depict and connect them).

How are new business beings born?  A paper by Liliana Doganova, member of the PERFORMABUSINESS team, and Martin Giraudeau, lecturer in accounting at the London School of Economics, proposes to study the populating of markets by looking at the very place where new firms are formulated and formed: the business plan. Research on business planning has tended to focus on consequences, with conclusions indicating that while business plans certainly help entrepreneurs learn and gain legitimacy in the eyes of external parties, they have little impact on the performance of the future firm. Our paper, instead, chooses to open the plans, to analyze their contents and to describe their uses. This method allows us to observe directly what they do, both in terms of visual formulation of the new venture and of its actual formation as a new business active on its markets.

In January, we presented a first draft of this paper, entitled “Entrepreneurial formulas: business plans and the formation of new ventures”, at a seminar at Centre de Sociologie de l’Innovation. The paper identified different techniques through which the future firm is put together in a business plan, and proposed to call them “formulas”. The business plan, we suggested, acts as a literary, chemical, financial and magical formula as well: it tells a story, made up of a limited set of characters and plots; it lists and bonds the resources that constitute the future firm; it transforms them into a stream of future revenues; and, in doing so, it helps bring into existence that which it describes.

The discussion of the paper raised interesting questions and opened new research paths. Isn’t it misleading, some colleagues asked, to envisage the business plan as a magic formula? How to describe the business plan – a peculiar object which is made to make do, which is addressed to a valuating agency (the investor), which is both inventively playful and rigidly standardized? What is the singularity of the business plan, as compared with, say, a project proposal, a scientific article, or an annual report? And, finally, if the business plan is a site to observe new business beings in the making, what does it tell us about the theory of the firm? We are currently incorporating these comments — new version of the paper will be made available sometime soon.

So what is capitalization about? And what would a social inquiry into capitalization look like? In a recent post, it was suggested that a social inquiry into capitalization requires “understanding capital not as a thing in itself — something that one has or has not — but rather as a form of action, a form of grip, a form of power, an act of configuration, an operation, a situation”. Where such an inquiry can draw inspiration from? Karl Marx’s analysis of capital as a “social relation” appears as an obvious place to start with.
In a chapter of Capital entitled “The Modern Theory of Colonisation”, Marx took up the story of Thomas Peel, a colonial promoter and early settler at Swan River, whose misfortunate venture had earlier been described by Edward Gibbon Wakefield in his book England and America (1833):

“Mr. Peel, [Wakefield] moans, took with him from England to Swan River, West Australia, means of subsistence and of production to the amount of £50,000. Mr. Peel had the foresight to bring with him, besides, 300 persons of the working class, men, women, and children. Once arrived at his destination, “Mr. Peel was left without a servant to make his bed or fetch him water from the river.”” (Marx, Capital, chapter XXXIII)

Wakefield had used Mr. Peel’s story to develop his theory of “systematic colonization”, arguing in particular that the price of land should be made high enough to ensure the availability of labour — otherwise, the labourers whom capitalists brought with them to the new settlements would do as those who came with Mr. Peel did: leave, to find their own piece of land. Marx, instead, used Mr. Peel’s story to depict capital as a social relation, rather than “a thing”. Mr. Peel’s problem, Marx wrote, was that he had “provided for everything except the export of English modes of production to Swan River”. And Wakefield’s real finding, Marx claimed, did not have to do with colonies and their management, but with the nature of capital: what Wakefield discovered, through Mr. Peel’s story, was that capital “is not a thing, but a social relation between persons [the capitalist and the wage-worker], established by the instrumentality of things”.

Marx reiterated this point in a chapter of Wage Labour and Capital entitled “The Nature and Growth of Capital”:

“Capital consists of raw materials, instruments of labour, and means of subsistence of all kinds, which are employed in producing new raw materials, new instruments, and new means of subsistence. All these components of capital are created by labour, products of labour, accumulated labour. Accumulated labour that serves as a means to new production is capital.
So say the economists.
What is a Negro slave? A man of the black race. The one explanation is worthy of the other.
A Negro is a Negro. Only under certain conditions does he become a slave. A cotton-spinning machine is a machine for spinning cotton. Only under certain conditions does it become capital. Torn away from these conditions, it is as little capital as gold is itself money, or sugar is the price of sugar.” (Marx, Wage Labour and Capital, chapter 5)

It is precisely in this process through which something “becomes capital” — i.e., capitalization — that we are interested. And there are two insights that we can draw from here. The first one has to do with conditions. For Marx, things become capital “only under certain conditions”, and these conditions are of a socio-material texture, they are made of “social relations … established by the instrumentality of things”. Studying the capitalization of a molecule today, for example, would entail describing the encounter between an investor and a scientist-entrepreneur and their interactions mediated by tools like business plans, Powerpoint presentations and valuation formulae. The second insight has to do with consequences. For Marx, while things become capital, “they serve at the same time as means of exploitation and subjection of the labourer” (Capital, chapter XXXIII). In a certainly less critical take, turning molecules into capital, to continue the example, goes hand in hand with turning scientists into entrepreneurs. A social inquiry into capitalization would thus involve an exploration of the kinds of objects and subjects that are produced in the contemporary settings of capitalization.

‘Cousin Thomas, or the Swan River Job’, an 1829 caricature of Thomas Peel by Robert Seymour. Source: National Library of Australia.

Thomas is exclaiming “Cousin Bob’s letter did the job I shall feather my nest however.”

On the left is a sign post “The best parts of the Swan River Settlement only to be got at through the hands of Mr. Thos P–l!!”