Accounting, Auditing & Accountability JournalEmerald Article: Value, profit and risk: accounting and the resource-basedview of the firmSteven TomsArticle information:To cite this document: Steven Toms, (2010),"Value, profit and risk: accounting and the resource-based view of the firm",Accounting, Auditing & Accountability Journal, Vol. 23 Iss: 5 pp. 647 - 670Permanent link to this document:http://dx.doi.org/10.1108/09513571011054927Downloaded on: 07-12-2012References: This document contains references to 102 other documentsCitations: This document has been cited by 3 other documentsTo copy this document: firstname.lastname@example.orgThis document has been downloaded 2401 times since 2010. *Access to this document was granted through an Emerald subscription provided by UNIVERSITY OF THE ARTS LONDONFor Authors:If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service.Information about how to choose which publication to write for and submission guidelines are available for all. Please visitwww.emeraldinsight.com/authors for more information.About Emerald www.emeraldinsight.comWith over forty years experience, Emerald Group Publishing is a leading independent publisher of global research with impact inbusiness, society, public policy and education. In total, Emerald publishes over 275 journals and more than 130 book series, aswell as an extensive range of online products and services. Emerald is both COUNTER 3 and TRANSFER compliant. The organization isa partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archivepreservation. *Related content and download information correct at time of download.
The current issue and full text archive of this journal is available at www.emeraldinsight.com/0951-3574.htm Value, proﬁt Value, proﬁt and risk: and risk accounting and the resource-based view of the ﬁrm 647 Steven Toms The York Management School, University of York, Heslington, UKAbstractPurpose – This paper aims to argue that the principal components of the Resource-Based View(RBV) as a theory of sustained competitive advantage are not a sufﬁcient basis for a complete andconsistent theory of ﬁrm behaviour. Two missing elements are value theory and accountabilitymechanisms.Design/methodology/approach – The paper proposes a link between value theory andaccountability using a Resource Value-Resource Risk perspective as an alternative to the CapitalAsset Pricing Model. The link operates ﬁrst from the labour process, where value is created but isimperfectly observable by intra-ﬁrm mechanisms of organizational control and outside governancearrangements without incurring monitoring costs. Second, it operates through contractualarrangements which impose ﬁxed cost structures on activities with variable revenues.Findings – The paper thereby explains how value originates in risky and difﬁcult to monitorproductive processes and is transmitted as rents to organizational and capital market constituents. Itthen reviews recent contributions to the RBV, arguing that the proposed new approach overcomesgaps inherent in the alternatives, and thus offers a more complete and integrated view of ﬁrmbehaviour.Originality/value – The RBV can become a coherent theory of ﬁrm behaviour, if it adopts and canintegrate the labour theory of value, associated measures of risk arising from the labour process andmechanisms of accountability.Keywords Resources, Risk management, Labour, Competitive advantagePaper type Research paper1. IntroductionTo what extent is strategy framed in accounting terms and what role do accountingnumbers and techniques play in setting strategy? In both cases the answer is probablynot enough, in view of the potential contribution on offer from accounting generally,and from critical accounting in particular. In recent years, the resource-based view(RBV) of the ﬁrm, has achieved widespread dissemination in academic literature andmanagement practice (Acedo et al., 2006). It explains competitive advantage, ordelivery of sustained above-normal returns (Peteraf, 1993) or economic proﬁt (Barney,2001), in terms of ﬁrms’ bundles of resources (Amit and Schoemaker, 1993; Rumelt,1984), which are valuable, rare, inimitable and non-substitutable (VRIN) (Barney, 2001,emphasis added). A theory linking asset value and abnormal returns is therefore Accounting, Auditing & Accountability JournalThe author would like to thank participants at the European Critical Accounting Studies Vol. 23 No. 5, 2010Conference, University of York, 2006 and the Institute of Chartered Accountants in Scotland, pp. 647-670 q Emerald Group Publishing Limitedwhose ﬁnancial support helped develop the ideas in this paper. He would also like to thank Chris 0951-3574Carter and two anonymous reviewers for their very helpful comments. DOI 10.1108/09513571011054927
AAAJ required. Because the RBV literature has placed these issues at the centre of its agenda,23,5 its neglect of the accounting literature all the more surprising. If the strategy literature has neglected accounting, it is also fair to say that accounting has neglected strategy. Where concerned with valuation, accountants often employ theoretical stances at variance with the Neo-classical mainstream strategy literature (Bryer, 1994, 1999; Macve, 1999; Mouck, 1994; Tinker, 1980, 2004; Toms,648 2006a, 2009; Toms and Bowman, 2010). A common approach of critical accounting is to begin with the restrictive assumptions of marginalist Neo-classical economics and argue that they possess logical inconsistencies, for example the tautological approach to asset valuation implied by the Cambridge controversies (Tinker, 1980), privilege interest groups (Tinker et al. 1982), or are not useful because the total social product is either not recognised (Mayston, 1992) or ignored (Milne, 1991), and neglect the social “essence” beneath the surface of market relationships (Tinker, 1984, p. 61, 1980, p. 158). As a consequence, much of the critical accounting literature has abandoned economic discourse, including the Classical and Marxian Schools. With limited exceptions, deductive model building has become unfashionable, even though, as will be demonstrated below, it has the potential to overcome some weaknesses of the Neo-classical School and its accounting applications. As a consequence, there are unresolved questions in accounting and strategy. First, what is the nature of value, and a theoretically consistent measure of sustained competitive advantage (SCA)? Second, can an operationalisable theory of risk be developed for the purposes of managerial decision making? In addressing these questions the paper will advance an agenda for strategy, and accounting. It will address them by developing an integrated theory of value, proﬁt, and risk. In section two the relevant literature is reviewed under three headings. First, the salient features of the RBV are analysed. Second classical theories of value are considered. Finally, the accounting literature is discussed, insofar as it reﬂects the former two aspects. Section three develops a new conceptual framework, linking proﬁt, value and risk as a basis for a theory of SCA. It will be shown how the labour theory of value (LTV) can be extended to include risk and be used to modify the neo-classical capital asset pricing model (CAPM). It will do so by linking both to the underlying labour process. It will demonstrate how proﬁt and asset value can be consistently linked by cost structures. It will show how value creation of value can be differentiated from the rent. In the fourth section, the implications are discussed, ﬁrst for accounting theory, with particular reference to the Cambridge controversies, and second by comparison with similar approaches in the strategy literature. A ﬁnal section draws conclusions. 2. Strategy, value theory and accounting Strategy and the RBV as a theory of value The RBV is an important idea in strategy, because it offers the potential to explain SCA, or the process of delivering long run abnormal returns to shareholders. Such returns can be delivered through accessing resources, including for example by monopoly control, as in the theory of competitive heterogeneity, or the creation of difﬁcult to replicate resources as in the RBV. It follows that the RBV needs a theory of value to be a convincing theory of SCA. As Priem (2001) therefore suggests, the RBV is incomplete because its explanation of value must be imported from outside literatures.
Further, as Priem and Butler (2001) propose, the RBV is tautological if the ﬁrm’s Value, proﬁtpossession of unique capabilities cannot be ascertained independently of their and riskdescription (Carter et al., 2008). Accounting might break the tautology by providingmechanisms for understanding resource creation, their valuation and reporting. Ittherefore follows that the measurement of resource value and abnormal returns arenecessary components of the development of the RBV as a theory. Of course, this conclusion has not been fully accepted in the strategy literature, 649which reﬂects more general disagreement about the RBV’s basic premises (Hoopeset al., 2003). Indeed, participants in the debate have yet to reach a consensus on thecircumstances of where, why and when a resource is valuable (Miller and Shamsie,1996, p. 539). Where recent strategy literature does acknowledge the requirement for atheory of value, it has adopted two quite narrow and largely mutually exclusiveperspectives. One strand examines processes within the organization (Denrell et al.,2003), which might be conceptualized in terms of production, transaction andgovernance costs (Madhok, 2002). Another considers value, price and cost as marketinteractions (Hoopes et al., 2003), and the market based division of value throughbargaining games (Lippman and Rumelt, 2003a, 2003b; MacDonald and Ryall, 2004;see also Brandenburger and Stuart, 1996). In contrast with economic theory, which explains performance differentials in termsof product and market structure, the RBV focuses on the internal characteristics of theﬁrm (Lockett and Thompson, 2001). However, the valuation of RBV assets also impliesrelationships with a speciﬁc market environment (Amit and Schoemaker, 1993).Similarly Barney (1991, p. 105) suggests that a resource is valuable to the extent that “itexploits opportunities and/or neutralizes threats in a ﬁrm’s environment”. A connectedargument is that resources are valuable if they enable a ﬁrm to satisfy needs at lowercosts than competitors (Peteraf, 1993). Barney (1991, p. 106) also suggests thatresources are valuable “when they enable a ﬁrm to conceive of or implement strategiesthat improve its efﬁciency and effectiveness”. A resource has been deﬁned as valuableif it enables customer needs to be better satisﬁed (Bogner and Thomas, 1994; Verdinand Williamson, 1994). How the superior returns that arise from these activities are captured by speciﬁcstakeholder groups through accountability processes has not been resolved in thestrategy literature. Coff (1999) addresses the question with the notion of “nexus rents”,so that proceeds of superior performance are appropriated by competing stakeholdergroups. Although explaining their distribution, rents, and one assumes value, aredetermined by market processes and do not arise from the productive process,although Coff’s contribution importantly highlights the role of monitoringrelationships. Where the stakeholder approach is used, deﬁnitions of value are stillpredicated on notions of utility. For example Collis and Montgomery (1997, pp. 30-1)argue that a resource is valuable when demanded by customers, when it cannot bereplicated by competition, and when the proﬁts it generates are captured by the ﬁrm(emphasis added). The implied reiﬁcation does not sit comfortably with a stakeholderapproach. However, the principal weakness here is that value depends upon deﬁningcustomer needs (including, tautologically, access to low priced goods) in utilitarianterms. There is also the more fundamental question of whether utility in any caseconstitutes the basis for a theory of value. It has been dismissed as a tautology by someprominent economists (Robinson, 1963), and more importantly refuted as a theory of
AAAJ capital value and the rate of proﬁt (Harcourt, 1969). Neo-classical economics has23,5 ignored rather than responded to these fundamental criticisms (Tinker, 1980), and any attempt to develop a resource based theory of the ﬁrm on neo-classical foundations necessarily faces the same problem, not least because capital values and proﬁt rates are central to the RBV approach. To summarize these problems, the RBV requires a value theory independent of utility, or must specify a stakeholder group whose utility is to650 take precedence. Strategic management researchers meanwhile are also interested in developing new risk measures that are theoretically consistent and useful for managerial decision making, achieving a suitable trade-off between concept complexity and computational simplicity (Rueﬂi et al., 1999, pp. 182-4). So far, this literature has relied on the CAPM, but has merely added to the critique in the ﬁnance literature. Bowman (1979) and Armour and Teece (1978) examined the implied CAPM relationship, ﬁnding a paradoxical negative slope between risk and return. Feigenbaum and Thomas (1986) and Singh (1986) ﬁnd differing risk return relationships at different levels of organizational performance and capacity utilisation. These studies typically reﬂect Neo-classical approaches to modelling risky behaviour, so that they are potentially undermined by the weaknesses of the CAPM highlighted by ﬁnancial researchers (Clare et al., 1998, Fama and French, 1992, Wang, 2000), and although address expected return, do not offer a theory of value. Summarizing much of the above, Priem (2001) argues that existing theories deal only with the value capture element but do not explain how value is created. For Makadok and Coff (2002) RBV works with value capture, but does not need a theory of value creation, especially not a theory based on consumer utility. Bowman and Ambrosini (2000) suggest conventional explanations of resource value (Makadok, 2001; Makadok and Coff, 2002; Barney, 1986; Peteraf, 1993; Collis and Montgomery, 1995) are insufﬁcient and set out a framework incorporating value creation and value capture. These critics have built on Classical economists’ notion of use value, so that new use value derives from individuals’ actions within the organization (Bowman and Ambrosini, 2000; Bowman and Swart, 2007; Lado and Wilson, 1994; Pfeffer, 1995; Wright et al., 1994). These approaches potentially form the most useful starting point for the more formal integration of the LTV and theories of SCA. Classical value theory In the classical LTV, human action within the productive process is the source of value. Because commodities are systematically sold at higher prices on leaving the productive process in comparison to the prices at which they enter it, there must be some commodity within the process that adds value systematically. Without this condition aggregate proﬁts are zero and the economy is a zero sum game. Further, labour time is priced in the market, but labour time is transferred to the product with a degree of intensity that is a function of physical effort and mental processes, which are not directly observable. Socially necessary labour time is that required to produce any use value under normal conditions of production with the average degree of skill and intensity prevalent in that society (Marx, 1984, p. 641). As far the RBV is concerned, it is not a theory of value, but a theory of rent. These rents are Ricardian (Peteraf, 1993, Teece et al., 1997, p. 513), since Schumpeterian rents (Foss and Knudsen, 2002), as synergies, or economies of scope are imitable, except in
the short run (Barney and Peteraf, 2003). However, none of the RBV literature has Value, proﬁtseriously concerned itself with the nineteenth century literature on rent and associated and riskvalue theory. Marx modiﬁed Ricardo by varying the assumption of a ﬁxed resourcesupply, and allowing rents to arise as a function of different deployments of capital. Healso explained the proportion of proﬁt manifested as rent as a function of theregulating price, as determined socially necessary labour. Rent therefore is regulatedby the most efﬁcient (or least efﬁcient) combination of resources and their production 651cost, depending on prevailing conditions of competition and the order in whichresources are brought into use. In other words, Marx’s theory of rent developedRicardo’s theory in directions of potential use to RBV theorists and accountantsconcerned with asset valuation and rents. Whether useful or not, Marx’s theory of rentis unlikely to be popular with RBV theorists or mainstream accountants. The same might be said for the LTV, although it is just as easily attributable toRicardo or Smith, or to classical economy in general. As Grant (1996, p. 112) puts it, “aphysiocratic approach”, locating value in a single production factor, is essential for aknowledge-based theory of value. Bowman and Toms (2010) introduce the notions ofvalue and surplus value along with the distinctions between use value and exchangevalue that have already contributed to the RBV conversation (Bowman and Ambrosini,2000). Following the above deﬁnition of socially necessary labour, ﬁrms will vary inefﬁciency and therefore through bankruptcy and innovation, socially necessary labouris reduced to the most efﬁcient ﬁrm (Mohun, 1996, p. 504). For these reasons Marx ismore speciﬁcally useful for the RBV as the notion of socially necessary labourfacilitates the determination of rent elements in abnormal proﬁts. Even so, Marx is onlya point of departure for the further development of RBV discussed in section 3.Accounting and the RBVThere has been limited research on the RBV in the accounting literature. Studies havetypically concentrated on testing managerial accounting applications. For exampleHoworth and Westhead (2003) ﬁnd that working capital management techniques differaccording to the scale and sophistication of the resource base in small ﬁrms. In anotherstudy, managerial selection of performance measures mediates the relationshipbetween strategic RBV assets and ﬁnancial performance in non-manufacturing ﬁrms(Widener, 2006). Other research has examined the relationship between themanagement control system (MCS), the creation of capabilities in an RBV sense andperformance (Henri, 2006). In general research of this kind has been limited, possiblybecause as Barney et al. (2001) suggest, the MCS is not a VRIN asset due to its easytransferability. In general, where undertaken by mainstream accountingresearchers, RBV research has focused on accounting practice rather thanaccounting theory. In contrast, critical accounting research has been more directly concerned with thesefundamentals. Toms (2002), Hasseldine et al. (2005) develop an integrated frameworkfor RBV intangible asset investment and stock market signalling. Bryer (1999) arguesthat labour values are the basis of objective asset valuations. Tinker(1999, p. 655) onthe other hand suggests that Marx’s economic categories such as proﬁt, wages andrents should be seen as socially relative phenomena. For Abeysekera(2008) accountingmeasurement is a response to commodiﬁcation, or the economic logic of maximisingthe market value of a ﬁrm while dealing with the contradiction of use of labour for
AAAJ production by the ﬁrm. Another strand of critical literature has begun to address the23,5 relationship between accounting proﬁt, valuation and the competitive process by integrating the propositions of the RBV. Toms (2006b) integrates a knowledge based view of the ﬁrm with theories of entrepreneurship, and extends the CAPM to integrate social conceptions of risk (Toms, 2006a). He extends these arguments to show the possible objective valuation measures that might be computed if social and ﬁnancial652 risk are appropriately integrated (Toms, 2008, 2009). Bowman and Toms (2010) show how the RBV can be integrated with Marx’s model of the circuits of capital incorporating different classes of labour. These ideas are now extended further to produce a conceptual framework based on a common theory of accounting and competitive advantage. 3. Conceptual framework Theoretical dimensions A theory of accounting and strategy is presented below, linking value theory and accountability, using what for shorthand will be referred to as the Resource Value-Resource Risk (RVRR) perspective. Value, in terms of labour effort transferred to the product, is best observable in the labour process by those most closely involved and the value capture process accordingly becomes progressively less observable (with increased monitoring cost) by those concerned with superintendence of valorization, or realization of use value into monetary value, and surplus appropriation. RVRR is thus concerned with accountability mechanisms, consisting of accounting controls and governance arrangements. There are several additional and important dimensions. First, is the ﬁrm’s cost structure, which refers to the degree of cost variability arising from the employment contract. If employee remuneration is not precisely linked to revenue, the expected (risk adjusted) rate of proﬁt includes a rent element. Either revenue will fall and staff costs are paid anyway, in which case there is a “rent” accruing to the workforce (because they have produced less but are paid the same), or revenue will rise and staff costs remain ﬁxed, in which case proﬁt rises above normal as labour’s share in net output falls. Second, if the actions of people within organisations are the source of use values, it is necessary to deﬁne such values according to some Minimum Efﬁcient Labour Requirement (MELR), otherwise any additional labour time, no matter how inefﬁcient and regardless of consumer requirement could still be said to create value. MELR speciﬁcally refers to the labour costs of the ﬁrm with the simplest processes and most easily replicable assets consistent with remaining in the market. It therefore regulates the market price and differential rents are set for other ﬁrms with less easily replicable assets according to the benchmark, as is analogous to the illustrations used by Marx (1984, chapters 39 [e.g. table 1], 40). The benchmark MELR ﬁrm establishes the underlying expected normal rate of return to shareholders and the discount rate applied in asset valuation. These relationships are developed further below to show that such returns are systematically related to cost structures embedded in the labour process. Third, there is the possibility of “rent” transfer between stakeholder groups. Rent is deﬁned as above, but extended to include circumstances where knowledge is unevenly distributed within ﬁrms and between ﬁrms and their investors, so that rents accrue to
ﬁrm insiders or ﬁnancial market insiders based on access to superior information. By Value, proﬁtextension, where knowledge is unevenly distributed within ﬁrms and between ﬁrms and riskand their investors, rents accrue to ﬁrm insiders or ﬁnancial market insiders based onaccess to superior information. Because ﬁrm insiders are employees and managers,their realized wage is the MELR rate for the job plus or minus rent elements arisingfrom access to information asymmetries in the production process and contract relatedcost structures. Conversely, realized returns accruing to shareholders in a ﬁnancial 653market reﬂect both the underlying rate of proﬁt plus or minus realizable managerialand labour rents. Unlike Ricardian rents in the standard RBV, these rents arise fromlabour processes within organisations and markets that are set in process by capital,and are accordingly consistent with Marx’s second category of differential rent, inwhich realized rent depends on differential employments of capital. The fourth component is tacit knowledge. Employees hold their positions becausethe perceived value of their tacit and other knowledge exceeds their market cost.To develop a theory of SCA from a RVRR perspective, it is necessary to establish abasic relationship between individual knowledge, the means whereby it is embeddedin the labour process, and subsequent monitoring and valorization. Physical effortand readily quantiﬁable skills are resources most easily replicable. Such explicit skillsare those more easily generated through generic training and education processesexternal to the ﬁrm. As labour processes become more deeply ingrained as tacitskills, they become more difﬁcult to replicate. As the ﬁrm invests in assets such asspecialized production facilities, trade secrets and engineering experience (Teece et al.1997) over time (Dierickx and Cool, 1989), tacit knowledge is embedded in technicallycomplex routines. According to the knowledge-based view SCA arises from suchroutines (Spender, 1989, Nonaka, 1991), but recognition that individuals create theknowledge, which ﬁrms can then apply (Grant, 1996) leads in the RVRR to tensionbetween rent appropriation by individuals and team-based proﬁt appropriation asSCA. RVRR places appropriate emphasis on the mental processes, so that seniormanagers as well as junior staff spend time creating value, speciﬁcally where theiradministrative activities are a necessary condition for productive activity to occur.Productive activity is activity that adds value including service provision, not justfactory production. The supervision problem intensiﬁes to the extent thatsubordinates hold tacit knowledge. Tacit knowledge reﬂects value in use ratherthan market exchange value and employees hold their positions precisely because theperceived value of their tacit and other knowledge exceeds their market cost. In RBVterms, the ﬁrm that employs such individuals has a basis for SCA because acompeting ﬁrm cannot replicate the asset base through straightforward marketexchange processes. Therefore a ﬁfth component is that, as the labour process is not directly observable,the employer of labour and the capital market investor are exposed to ﬁnancial riskarising from information asymmetry. Such problems lead to the sixth and ﬁnalcomponent, which is the process of organizational control and the mix betweenbehaviour and output controls (Ouchi and Maguire, 1975) or action and results controls(Bryer, 2006). The balance shifts from the former to the latter, to the extent that processobservation by supervisors is problematic, where accounting controls receive moreemphasis in the latter case. Each of these components is integrated in the followingframework.
AAAJ An integrated model23,5 Figure 1 uses the Ambrosini and Bowman (2001, p. 816) continuum to include tacit knowledge as a starting point, but extends their analysis to include the additional dimension of task complexity in the labour process, and cost behaviour, monitoring costs, control mechanisms and appropriation in the valorization process. In other words, to consider the relationship between knowledge location and value appropriation as part654 of a full description of the productive process, set out in Figure 1 as a horizontal continuum of dimensions of value creation through to ultimate value capture. The valorization process comprises four elements: cost behaviour, control, monitoring, and appropriation. Insofar as speciﬁc assets associated with SCA are not valued in an external market, and are therefore illiquid and non-realizable, they generate ﬁxed costs rather than variable costs. Similarly hiring knowledge intensive labour generates ﬁxed cost. Therefore as tacit knowledge and the potential degree of SCA rises under RBV assumptions, so does the ﬁxity of cost. As suggested in Figure 1, there is also a continuous relationship between the degree of tacitness and complexity in the labour process and the ability of external stakeholders to monitor the separable labour processes that make up the ﬁrm and their joint interactions. This follows from the deﬁnition of tacit knowledge, because the process is less readily explainable and understood by an outsider and, consistent with the RBV, tacit knowledge is implicated in SCA. External stakeholders’ two methods of monitoring, behavioural (or action) control and output control, are also implicated in the tacitness and complexity of the labour process, and the extent of ﬁxed production costs and monitoring costs in the valorization process. Tasks that are simple to perform and replicate are more easilyFigure 1.The production process,knowledge location andthe distribution of surplus
controlled through the division of labour and repetition, and more easily ﬂexed in Value, proﬁtresponse to changes in demand, so there is greater emphasis on action control. Where and riskthe process is complex, difﬁcult to observe and dependent on embedded ﬁxed costs,rather than costly monitoring a process that is difﬁcult to understand andunresponsive to changes in demand, output control might be relied upon, so that theproducer has to account for actions in ﬁnancial terms. In the latter case, there is anadditional element in the labour process, involving transformation of heterogeneous 655physical and mental inputs into homogeneous monetary outputs. Following Ouchi andMaguire (1975), behaviour and output controls may not be direct substitutes, but maybe observable in independent contexts depending on understanding of means-endsrelationships and complex interdependencies respectively. Finally, as far asappropriation is concerned, the more tacit labour processes create assets that areunique and valuable, through processes that generate difﬁcult to monitor ﬁxed costs,the more likely resulting abnormal proﬁt will be appropriated by insiders. Insideappropriation is at the expense of external capital providers or of other participants injoint ventures and consortia. Several corollaries arise from these relationships. First is the conﬂict between themanagerial objective of achieving SCA and the objective of maximizing shareholdervalue. Managers pursue rents rather than optimal growth (Rugman and Verbeke, 2004)and these rents arise from their role in the labour process, as supervisors andparticipants. If ﬁrms are identiﬁed as achieving competitive advantage by reference toaccounting ratios showing superior performance from a shareholder perspective (e.g.Peters and Waterman, 1982), such performance is likely based on explicit and easilyreplicable skills and that associated competitive advantage is short-term or illusory. A second and related point is that monitoring costs in Figure 1 also lie on acontinuum suggesting that as the degree of tacitness rises, the probability of surplusappropriation by those closest to the labour process also rises. In other words themonitoring problem is not simply conﬁned to the providers of external capital but isalso faced directly by the line managers at each hierarchical level above the labourprocess. Line managers have the incentive to externalize tacit knowledge embedded inlabour processes for which they are responsible, for example through the division oflabour, or spend organizational resources themselves on monitoring, so that rentsaccrue at their level of the hierarchy. Insofar as line management itself is part of thelabour process, for example where managerial action alters the product or servicedelivered, further individually appropriable tacit knowledge arises and monitoringcosts are imposed from above on progressively senior levels of management.Ultimately the imposition comes from the capital market to the top of the hierarchy,creating a similar but separate set of monitoring issues discussed below. A third corollary is that under RVRR assumptions the RBV is made consistent withlabour process theory (LPT). Many labour process theorists (e.g. Knights, 1990,Wilmott, 1990) stress the role of power rather than proﬁt and, where applied to the RBV,the role of power in appropriation (Scarborough, 1998). As Nicholls (1999) has pointedout, the valorization stage of the productive process, concerned with transformation oflabour use values into realized proﬁt, has been neglected in the labour process literature.Figure 1 suggests an integrated approach, since labour rent originates in the productiveprocess, and a valorization stage is included. In terms of labour time, capital comprisesaccumulated prior use values plus the labour time, at whatever intensity, transferred
AAAJ into output through the labour process. Capital can be conceptualized in labour hours23,5 without reference to valorization, but the valorization process is nonetheless the crucial link underpinning the relationship between tacit knowledge and monitoring costs. Valorization, under RVRR assumptions, depends on the effectiveness or otherwise of supervisory arrangements to moderate the effects of information asymmetry. Asymmetry arises because employees sell but usually retain some control over the656 employment of their labour effort, which supervision arrangements are intended to counteract in order to achieve fuller valorization. Therefore the labour process leads to inventiveness on the one hand through the imagination of individual employees and alienation through the process of specialization on the other. In the RVRR extension, to the extent that inventiveness and knowledge can be individually appropriated by employees, the labour process itself becomes a risky set of activities for administering managers and outside ﬁnancial stakeholders. Arising from these risks, a fourth corollary is their price impact capital markets. If SCA is measured in terms of shareholder returns, then realization through circulation in capital markets is part of the valorization process. At the top end of the continuum where all knowledge is tacit, it is impossible for the investor to understand the processes whereby use values are transformed into exchange values through realization and thereby generated into proﬁts. Even so, where there is some degree of capital dependence (Prechel, 2000), for example in high growth sector ﬁrms, insiders will have an incentive to reserve some proﬁt and signal its availability to outside investors instead of appropriating it for themselves. Insofar as the labour process within one ﬁrm is unrelated to labour processes governing the average ﬁrm’s realization of proﬁts, which include many explicit processes, its variation in proﬁt will appear random. Because the capital market by deﬁnition can only value explicit processes, that ﬁrm’s apparently random changes in proﬁt corresponds to the ﬁrm-speciﬁc risk from an investor’s point of view. In the limiting case where all knowledge is tacit, all share prices become random. Under such conditions, following Grossman and Stiglitz (1980), share prices would convey no information to investors. In the opposite case where all knowledge is explicit, information is symmetrical and markets become thin, as there are no abnormal returns (rents) and no incentive to trade (Grossman and Stiglitz, 1980). Also under these conditions with RBV assumptions all ﬁrms possess the same easily imitable resources for the same activities and there is no SCA. These intra-ﬁrm and ﬁrm-ﬁnancial market interactions provide the possibility of theory of proﬁt determination consistent with notions of SCA and the RVRR. Abstracting from the continua in Figure 1, a model showing the relationship between the labour cost characteristics of tacit knowledge, task complexity, valorization process characteristics, and expected proﬁts required by external investors can be developed. Figure 2 shows the rate of return required by a risk-averse external investor as a function of the ﬁxed cost labour ratio (FCLR). The FCLR is the proportion of ﬁxed cost to total cost for ﬁrm i divided by the proportion of ﬁxed cost to total cost for all ﬁrms. Some abstraction will assist interpretation of Figure 2. Suppose a ﬁrm with a single employee, w, and a single shareholder, s, and that the actions of w can be made totally observable or explicit to s through contractual/legal arrangements so w has no bargaining power. Suppose also that s pays w only for the output actually produced (as opposed to for the time w spends at work). Under these assumptions, s is able to appropriate proﬁts from the labour process under risk free conditions. If fairly efﬁcient
Value, proﬁt and risk 657 Figure 2.capital markets are also assumed, and other markets are perfect, the expected rate ofproﬁt should resemble the rate of return from risk free investment (point A in Figure 2),for example base interest rates. It can also be seen that if these assumptions aregradually relaxed, so that w is able, through the acquisition of bargaining power, to ﬁxwages in the face of varying demand conditions, then the rate of proﬁt required tocompensate the investor will rise. Because rate of proﬁt variability increasesproportionately to the degree of ﬁxity in wage cost, even where diversiﬁed, investorsrequire, and should obtain where capital markets remain reasonably efﬁcient, aproportionate increase in compensation (for the average risk ﬁrm, to point B inFigure 2). There is a systematic increase insofar as under conditions of aggregategrowth expected change in aggregate demand is positive in which case because wagesare ﬁxed, the rate of realized proﬁt rises. An important reason for the positive linear association between ﬁxity of labour costand shareholder risk is implicit contract theory, in which employees are risk averse(Rosen, 1985). In this model, the capital market absorbs the insurance element of implicitlabour contracts through a risk premium. Figure 2 is theoretically consistent with theSharpe (1964) and Lintner (1965) CAPM, in that stock return is proportionate tosystematic risk. The difference is that the risk source is related to value creation, labourprocess and value appropriation, rather than mere share price and stock market indexco-variation.
AAAJ Suppose next that w has tacit knowledge and can conceal value-creating or23,5 value-destroying activities in the labour process, so that the effort bargain shifts in favour of w and the return to s corresponds to point C in Figure 2. Again, s faces increased risk, but the increase is speciﬁc to the labour process and s avoids this risk by incurring monitoring costs or shifting to output control, for example setting a target normal rate of proﬁt based on observable rates elsewhere. These rates reﬂect, and are658 reduced by, aggregate monitoring cost. Alternatively, s avoids risk through portfolio diversiﬁcation, but in doing so reduces capacity further for monitoring performance of any one ﬁrm. Purchasers of other shares also run the risk of negative rents through premium prices charged by market makers, beneﬁting from inside or asymmetric information advantages (point D in Figure 2). In general, points C and D constitute examples of rents arising from non RBV sources, such as monopoly power, information asymmetry and other elements of competitive heterogeneity. The interactions between tacit knowledge and monitoring costs are suggestive of some interesting contradictions within the corporate economy. Alienation, through excessive specialization and associated removal of intellectual content, is traditionally viewed as a source of exploitation by unscrupulous proﬁt maximizers. That said, in industries where such exploitation might occur, such as cotton textiles in the British industrial revolution or in modern China, although aggregate proﬁt rates may be high, there is no basis for SCA at the level of any individual ﬁrm. In contrast, where the labour process has signiﬁcant intellectual content, thereby creating entry barriers for competitors, the accrued proﬁt to individual proﬁt maximizers may be still small and the rents accrued by intermediate producers and market-makers large, due to increased monitoring problems. In short, because rent is the difference between realized price and underlying value, if labour is the source of value, information asymmetry is the source of rent. Interaction between the two tends to equalize the aggregate rate of proﬁt. Figure 3(a) shows a formal decomposition of total observed proﬁts into proﬁt and rent elements. Following Figure 2, there is a risk free proﬁt element, to which is added a labour rent based systematic premium equating to the FLCR. Further rents arise from knowledge-based asymmetries within the production process and as a residual category, from other non-labour based resources. Consistent with the economic theory advanced so far, total observed proﬁt consists of normal proﬁt plus rents. Normal proﬁt, following Figure 2, corresponds to average levels of ﬁxed labour cost, corresponding to point A in Figure 3(a). A ﬁrm operating here would be the regulator of market price and the benchmark for differential rents arising at points B and C. To the extent that the individual ﬁrm has an above average FLCR, it earns systematically higher rent, which forms the ﬁrst component of RVRR-based abnormal return. The second component arises from knowledge-based production process asymmetries. SCA associated with the RVRR, consistent with the RBV, is the distance B – A. Further rents, accrued through heterogeneous access to other physical and informational assets (C – B), are not part of an RBV story of SCA, but are consistent with competitive heterogeneity and Ricardian rents. Where such rents are present, they will complement other categories of rent, thereby increasing total observed proﬁt, or will increase proﬁt in the absence of other categories. For the purposes of simplicity expected and realized proﬁt are part of the same total observed surplus in Figure 3(a). In practice, expected and realized proﬁts are in contradiction. Figure 3(b) shows how these interactions, including the consumption of rent by internal stakeholders, explain
Value, proﬁt and risk 659 Figure 3. The determinants of sustained competitiveadvantage and observable proﬁts
AAAJ the observed level of proﬁt and when and how observed abnormal proﬁts are23,5 associated with SCA. Figure 3(b) shows the general case, in which proﬁts and SCA are explained jointly by tacit knowledge VRIN assets in the resource base and the process of surplus appropriation. The framework shows the labour and valorization processes to be in direct and dynamic contradiction. In the top row of the table, consistent with the RBV, ﬁrms achieve SCA through their tacit knowledge resources. However,660 observable proﬁts differ, so that where accountability mechanisms are effective, proﬁts from SCA are above normal and accrue to external stakeholders (quadrant 1). Where accountability mechanisms are ineffective, rents accrue to insiders (quadrant 2). Reported proﬁts are normal, since insiders will report and distribute the level of proﬁt required for minimally satisfying investors and preventing them from exiting their investment. Remaining surplus will be consumed as rents by insiders. On the bottom row, there are no VRIN assets and therefore no basis for SCA. Because there are no VRIN assets, rent appropriation by insiders is also impossible. Proﬁts are therefore normal in both quadrants 3 and 4. In quadrant 4, losses (i.e. less than normal proﬁts) are possible if managers are not well monitored and appropriate rents, but only in the very short-run. Because there are no VRIN knowledge assets, the normal rate of proﬁt is well known and therefore deviations below are easy to police. Insofar as SCA and abnormal proﬁts only occur consistently in quadrant 1, accountability mechanisms contribute to observable competitive advantage. Even here the trade-offs referred to in Figure 1 still apply, so that increased investment in VRIN assets also increases monitoring costs. Therefore abnormal proﬁts and SCA are only concurrent where accountability mechanisms are cost-effective. In short, heterogeneous value creation processes and cost-effective accountability mechanisms are jointly necessary and sufﬁcient conditions for SCA. There are relatively few devices available to outside investors to ensure that their ﬁrm operates in quadrant 1. An example might be to recruit outside directors with sufﬁcient independence from the main board but who simultaneously possess the sector-speciﬁc expertise required to monitor knowledge based assets. However, in the general case, availability of such directors suggests inter-ﬁrm knowledge sharing which is in itself inconsistent with ﬁrm-level SCA. A possible solution is ideology, and notions such as “shareholder value maximization”. Arguably, such notions might be more easily shared between outside investors and the ﬁrm’s top management. Top management might therefore employ ideology to mitigate apparently selﬁsh utilization of tacit knowledge-based wealth consumption by organizational insiders, consistent with Penrose’s view that ﬁrms and their managers are essentially proﬁt-orientated, and that managerial opportunism and the agency problem constitute only a special case (Lockett and Thompson, 2004). However, there is little rational basis for managerial pursuit of abnormal proﬁt, since it derives from a contradictory appeal to the selﬁsh interests of another group, i.e. the shareholders, and because normal rather than abnormal proﬁts are a sufﬁcient basis for the ﬁrm’s survival. If ideology by itself is insufﬁcient, the use of trust in limited measure down the hierarchy in combination with ideology based sanctions (Armstrong, 1991) may be necessary to achieve quadrant 1 outcomes. The trade-offs in Figures 1 to 3 explain participants’ behaviour in a dynamic system operating within social and technically determined limits. There is an incentive to invest in knowledge assets insofar as the marginal product is positive net of
monitoring costs. Because tacitness can rise to the point of total opacity there is an Value, proﬁtupward limit on the investment level. Similarly there is a downward limit to alienation, and risksince if all processes are explicit, although monitoring costs are zero, individual ﬁrmscannot achieve SCA under RBV assumptions. The realized rate of proﬁt for theﬁrm, as an asset bundle, depends on the interaction of these contradictions, but isunrelated to the competence or otherwise of the ﬁrm’s management, who, whererational, will appropriate surpluses privately. The rate of surplus accruing to 661individual employees and managers depends on the possession of knowledge andmonitoring cost.4. DiscussionImplications for accounting theory: the Cambridge controversies revisitedOne of the most important potential implications of the model is for the problem of thevaluation of heterogeneous assets, or capital goods (Wicksell, 1934). Conventionally,asset value is the present value of the future cash ﬂows the asset is likely to generate,presupposing a discount rate and therefore a rate of proﬁt. However in the RBV asin neo-classical economics, the rate of proﬁt follows from the possession of valuable(scarce) assets. Wicksell effects and the associated Neo-Ricardian problems of capitalreversing and re-switching are important challenges to the RBV, since they implysimultaneous equilibria where ﬁrms comprise different combinations of labour andcapital at different rates of proﬁt. If either labour or capital is a VRIN asset, theimplication is that they are only likely to hold such status within a certain range ofproﬁt rates. These issues were raised in the “Cambridge controversies”, but neversatisfactorily resolved (Cohen and Harcourt, 2003). An alternative approach is to value capital assets according to cost of production.Wicksell effects also bedevil this approach, because there is a periodic need to revaluethe capital stock to reﬂect price and technology changes. However, from the RVRRperspective, these problems are more tractable, and capitalization rates can be derivedfrom the internal contractual structure of the ﬁrm. As Figure 2 shows, the risk adjustedrequired rate of return is a linear function of embedded ﬁxed labour cost. Figure 2 isalso generalizable from labour to other classes of cost, using the same ﬁxity of costapproach. Moreover, corporate boards can impose these expected returns onbusiness units using output controls. Although problems of asymmetric information,possession of tacit knowledge and monitoring costs impact on individual valuations,the associated risks are diversiﬁable by investors and have no systematic impact onexpected returns or required capitalization rates. In general therefore, rationalvaluations for heterogeneous assets, for example RBV style intangibles, can be arrivedat by examining the underlying social relationships and associated cost structurewithin the ﬁrm.Implications for strategic managementSuch a focus also addresses the need for theoretically consistent risk measuresidentiﬁed in the earlier review of the strategy literature. Also, the RRVR approach tosome extent parallels Madhok’s (2002) response to Williamson’s (1991) call for anintegrated approach, albeit without the restrictions imposed by the reiﬁcation of theﬁrm and absence of shareholder-based governance mechanisms that tend to occur insuch transaction cost RBV analyses. In reality, because outside shareholders can only
AAAJ apply output controls to top management, they must rely on accounting23,5 representations of results, leaving top management, crucially, in control of the process of transformation of heterogeneous capital resource into homogeneous cash ﬂow equivalent representations. Therefore top management also have the ability to promote internal reinvestment of proﬁts from innovation into perquisites at the expense of dividend payments to shareholders. Also the way in which the ﬁrm’s662 managerial hierarchy exercises surveillance is potentially important, through access control or incentivization, respectively examples of action and output controls. There are other similarities between RVRR and Denrell et al. (2003), who assume that all stage transformations through intermediate to ﬁnished products require only labour cost and that labour is undifferentiated. They also assume that all prices are in present value terms. It follows that the discount rate, or more precisely, the risk-adjusted rate of proﬁt, is presupposed. If it is necessary to assume wage rates, prices and proﬁt rates a priori, in a model with two factors of production, labour and capital, it is difﬁcult to see how this model rigorously adds to the theory of value. The Lippman and Rumelt (hereafter L&R) bargaining and payments perspectives also have similarities to the RVRR approach. Unlike RVRR, however, the L&R approach lacks an underlying theory of value creation. The bargaining approach assumes a surplus (Lippman and Rumelt, 2003b, p. 1071, emphasis added). Alternatively for the payments perspective, (Lippman and Rumelt, 2003a) economic proﬁt is set at zero, presumably for all ﬁrms in aggregate, implying differences in price and cost sum to zero, or revenues 8 payments. At the aggregate level, these are merely wealth transfers. In contrast, RVRR offers an explanation as to why on aggregate the value of purchased outputs is systematically higher than purchased inputs. According to Lippman and Rumelt (2003b), value distribution depends on the structure of a bargaining game. A condition is that the game should have a core otherwise the participants lack the incentive to work together for a co-operatively beneﬁcial outcome. Where an innovative employee possesses tacit knowledge, it is unlikely that person will enter the game unless the ﬁrm’s incentive structure is such that the employee will appropriate a signiﬁcant share of revenues. Where ex ante contracts of employment specify the ownership and rewards from innovation as proprietary to the ﬁrm, these incentives will not exist. Assets that achieve this, such as proprietary technology and large ﬁxed asset bases, restrict access from the employees’ point of view and prevent them setting up a competing ﬁrm. At the same time, they ensure inequality in bilateral bargaining gains, encouraging indirect rent appropriation. The appropriation process in this case, outlined in the RVRR, arises from non co-operation by the innovative employee and imperfect surveillance of effort by the employer, so that rent arising from innovation and greater efﬁciency is appropriated by ﬁrm insiders through equivalent shirking. An alternative contractual arrangement, which gives the employee incentive to share information, places a core in the game, but with the risk that the employee appropriates some monetary beneﬁt. A further problematic aspect of Lippman and Rumelt’s (2003a, p. 924) analysis is their concluding objective function, that the ﬁrm should maximize its wealth and that competition will induce it to maximize payments for scarce resources (PSR). PSR is a residual category, once payments of commodity inputs (PCI) and payments for commodity resources (PCR) have been accounted for. Because the other two categories are deﬁned as commodities, they are also deﬁned to be in perfectly elastic supply. If
Revenue ¼ PCI þ PCR þ PSR and the ﬁrm is a price taker in two out of the three Value, proﬁtcategories, then changes in PSR can only be explained with reference to themselves, and riskwhich removes any analytic properties from the identity. If on the other hand, perfectcompetition is as deﬁned by Makowski and Ostroy (1995) and Lippman and Rumelt(2003b, p. 1071), as a condition in which individuals fully appropriate the value theycreate, then market imperfection implies transfer of surplus through rent (per classicaltheory) rather than value. It also follows that if individuals do not fully appropriate the 663value they create in a market relation other than in perfect competition, this will also bethe case in an employment relation. RVRR, which includes labour rents, does betterthan Classical theory and the sections of the RBV literature that ignore the creation ofvalue through human action. The value price cost (VPC) framework approach differentiates between value,deﬁned as the price the customer is willing to pay; price, which is a function of supplyand demand; and cost, which is the cost of production. The framework assumes V . P. C, which is likely to be true when individual cases of competitive advantage areconsidered, and competitive advantage might arise in individual cases of V . P and P. C (Hoopes et al., 2003). However, in the aggregate V ¼ P ¼ C, otherwise it is notclear why customers would systematically value all products and services above theircost of production. The equality of VPC in the aggregate is also consistent with thepayments perspective (Lippman and Rumelt, 2003a), but inconsistent with anunderlying theory of value creation. If V is systematically higher than C in theaggregate in price terms, then ﬁrms must be acquiring a resource for a price below itscost. The only resource all ﬁrms share common access to is human resource. As wehave seen, it is this resource in particular that not only creates value throughintellectual and physical effort, but such effort is also problematic to measure andobserve, unlike the costs of other inputs. In similar fashion to the VPC approach, MacDonald and Ryall (2004) attempt toshow that value arises from the presence of a willing buyer. In the case presented(MacDonald and Ryall, 2004, p. 1321), the cost of production is normalized to zero andthe buyer’s utility is set at 1. To presuppose utility at a level greater than the cost ofproduction, is however, non-generalizable, since without equivalent payments toproduction factors utility cannot constitute effective demand. If the case is merelyspeciﬁc then the bargaining game is a question of rent sharing between ﬁrm and buyer,rather than value creation. Consistent with M&R, the appropriation of value dependson the number of ﬁrms and buyers. As in many interpretations that analyse at the levelof the ﬁrm, there is reiﬁcation and no consideration of rent splits within theorganization. As with L&R, the M&R analysis could be extended to include theemployment relation, so that bargaining is represented as an interaction betweenemployee and employer as a buyer of labour.5. ConclusionA common theory of value for accounting and strategy is appealing for a number ofreasons. First, the strategy literature, and especially the RBV, places emphasis on therole of human capital in the creation of competitive advantage, which at the same timeposes problems for accountants in terms of total business and intangible assetvaluation. Second, both disciplines have an interest in understanding the meaning ofnormal proﬁt and its adjustment for risk where it impacts on performance or
AAAJ investment decisions. Third, both disciplines are interested in how, once made, proﬁts are appropriated. A situation where a ﬁrm is more efﬁcient than competitors, but23,5 whose surplus is appropriated by insiders rather than distributed to shareholders would not necessarily meet the strategists’ understanding of SCA. Accountants similarly are concerned with controls which prevent misappropriation of resources that ultimately are shareholders’ property. Thus, a theory of value also needs to be one664 of accountability. Accordingly, the theory developed above has attempted to integrate these elements to the mutual beneﬁt of accounting and strategy. The contribution of the paper is a theory of SCA, asset valuation and accountability using a consistent theory of value. The argument above has accepted the main assumptions of the RBV. It has also argued for the inclusion of labour process theory, asymmetric information, extension of Ricardian rent using Marx’s two categories of differential rent, and the analysis of risk, in the proposed RVRR. The combination of these elements shows that a resource-based theory must unite the process and content elements of strategy, through simultaneous interaction of labour management, the determinants of SCA and relations with capital markets. It has shown that by utilising the RVRR as a substitute for the CAPM, so that the employment of human resource creates value, but the value creation process is itself risky from the perspective of the monitoring employer and outside investor, a consistent theory of value can be applied to explain SCA. The theory also explains that the roots of competitive advantage lie in the labour process, but with the corollary that maximizing the associated investment in tacit knowledge and associated difﬁcult to replicate assets is potentially inconsistent with maximizing the value of shareholder’s investments. Without the links, advocated above, to LTV, labour process theory and mechanisms of accountability, the RBV remains merely a view and not a theory, because it lacks a consistent basis for asset valuation and cannot explain systematic variations in proﬁt. Notes 1. In similar vein, the RBV had been neglected in the industrial economics literature (Lockett and Thompson, 2001). 2. Without measurement, the RBV might still operate, but only as a heuristic, or a means of understanding an organization as a knowledge system, such that the link with “value” is tangential, and not as a theory of SCA. 3. Ricardian differential rent is “the difference between the produce obtained by the employment of two equal quantities of labour and capital” (Marx, 1984, p. 649). 4. Such allusions to Classical theories of economics are rare in the strategic management literature notwithstanding the obvious parallels with the LTV and Ricardian rents. LTV, as the cornerstone of Classical economics (Mouck, 1994) has been discussed extensively in the accounting literature (for example Bryer, 1994, 2007; Toms, 2006a). 5. Henri(2006, p.539) suggests that the performance measurement system (PMS) does create RBV capabilities. 6. This deﬁnition goes beyond the debate in the accounting literature about how Marx’s socially necessary labour time might be in an accounting context (Bryer, 1999; Macve, 1999). 7. Labour rents accrue to employees (and managers) where the wage rate exceeds the MELR. Where employees possess knowledge that is not easily replicable, particularly when routinized within the organization, possession of such knowledge provides workers with
opportunities to raise real wages, if they can avoid accountability and appropriate the Value, proﬁt efﬁciency beneﬁts (c/f efﬁciency wage theories, Katz, 1987). and risk 8. This is an oversimpliﬁcation for the purposes of model development. It extends reasoning that stakeholders earn quasi-rents when a factor has a higher marginal product than is required to hold it in place (Klein et al., 1978). 9. Investment in strategic human resource assets (Mueller, 1996; Wright et al., 1994) is a sufﬁcient but not a necessary condition for realized super-normal proﬁts, since the 665 employment of such assets simultaneously leads to the creation of internal rent appropriation possibilities.10. As seniority increases managers may ﬁnd more of their time allocated to non-productive monitoring activities.11. Although there is an incentive, it is doubtful whether full externalisation is possible. Using Dewey’s notion of productive enquiry, Cook and Seely Brown (1999, p. 391) argue that possessed knowledge, whether individual or group, is a set of tools to guide action. Within organisations, genres, such as mission statements, are used (or misused) to communicate tacit knowledge in groups. Following this logic accounting controls must monitor how individuals and groups use knowledge.12. RBV and LPT are from divergent backgrounds within the strategic management literature, reﬂecting context and process based approaches respectively.13. Under the normal semi-strong market efﬁciency assumptions employed by capital market researchers and for which there is the most empirical evidence (Fama, 1991), explicit processes are public domain information and their value potential can accordingly be priced by the market. Tacit elements cannot be known and cannot be priced by reference to generic economy wide factors systematically affecting all ﬁrms and therefore appear as residual or unexplained risk in the empirical form of the CAPM.14. It is assumed that labour is the only cost and that there is a single period capital turnover (ie all the assets purchased at the beginning of the period are used up by the end of the period). These assumptions are for brevity, but the model is generalizable when they are relaxed.15. Because labour cost co-varies perfectly with revenue, the residual, proﬁt, is a ﬁxed ratio of revenue.16. Assuming unlimited product imitation, as a form of Bertrand competition, MacDonald and Ryall (2004) reach a similar conclusion.17. For example where abnormal returns from insider stock purchases rise as the ﬁrm’s R&D intensity increases (Coff and Lee, 2003).18. The lack of a consistent theory of proﬁt equalization has been a long-running problem for classical economics. In RVRR, differential risky proﬁt rates arise in the productive process and are equalized through the capital market.19. Or more precisely, removing the reiﬁcation, individual capitalists or investors cannot make abnormal returns.20. Tinker (2004, p. 458) points out that Sraffa’s critique built on the ﬁnal works of Ricardo to expose this circular reasoning behind Neo-classical value theory.21. See Modigliani and Miller’s (1958) example utilizing interest costs.22. The core is deﬁned as the set of pay-offs that ensure the sub-set of pay-offs to any sub-set of players is greater than the maximum value available to that group working on its own (Lippman and Rumelt, 2003b, p. 1072).
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