Intangible Assets Plus Hard Numbers Equals Soft Finance

Finance used to be the hardest of business functions: number crunching, bean counting. Now hard assets like plant and equipment have given way to intangibles like ideas and relationships. How does the new math of the new finance add up?


Things used to be what chief financial officers, merger-and-acquisition strategists, bankers, and fund managers were paid to keep track of: tangible assets that determined a company’s value. Those things were, quite literally, things: plant and equipment, factories and machinery, buildings and inventory. They were assets that determined a company’s value, assets that could be measured and used to calculate return on investment. Those assets were solid, and so were the financial decisions based on their value.


But in the world of finance today, things aren’t what they used to be. In the new economy, the most valuable assets have gone from solid to soft, from tangible to intangible. Instead of plant and equipment, companies today compete on ideas and relationships. Assets come in the form of patents, knowledge, and people. These kinds of assets are soft and squishy, and number crunchers and bean counters hate them. How do you assign a dollar value to an engineer’s startup experience? How much is a personal network worth? How do you decide whether to finance a new internal project when its only assets are an idea and a team?

Hard questions about soft assets are driving finance professionals to develop new measurements, new reporting forms, new tools and techniques for an economy based on intangibles.

At Macromedia Inc., for example, a San Francisco – based Web-software company, CFO Betsey Nelson finds herself calculating value based on how close the company can get to its customers. “We’re looking at the value over time of a relationship,” she says.

At Silicon Valley Bank, in Santa Clara, California, Ken Wilcox leads his loan officers in equating company value with the value of people networks inside and outside the company: “A management team that can change fast is of the greatest importance,” says Wilcox, SVB’s president, chief operating officer, and chief banking officer.

At Nortel Networks Corp., a Brampton, Ontario – based maker of gear for voice and data networks, Klaus Buechner, the company’s mastermind of merger-and-acquisition strategy, assigns a high value to any acquisition that promises to accelerate Nortel’s entry into markets for Internet-protocol networks. “The driving motivation in this new dynamic is time to market,” Buechner says.


At California Public Employees’ Retirement System (CalPERS), in Sacramento, Bob Boldt, who is in charge of investing more than $140 billion in retirement money, finds value in companies that can motivate individuals. “As the external owners of a company, we want to know that the guys who are in there making decisions for us on a day-to-day basis — the engineers, the managers — have the same interests as we do,” says Boldt.

What emerges from these people’s experiences are valuation methods that mix the traditional and the new: cash-flow analysis and scenario analysis, discipline and experimentation. Together, they are setting the standards of soft finance.

The Value of Relationships

Betsey Nelson, 38, knows all about intangible value. As CFO of software maker Macromedia, she lives in a world of soft finance. Her number-one worry: “people assets” — the engineers who help Macromedia create some of the favorite tools of Web-page designers, including products like Director, Flash, Fireworks, and Dreamweaver. About the only tangible asset on Nelson’s balance sheet is the structure that houses her company, a modern office building in Silicon Valley.

“Everything we do is intangible,” she laughs. “The top line, the bottom line, everything is intangible. We are the poster child for intellectual property.” Macromedia, a high-tech oldster formed in 1992, has 550 employees and an executive team made up of baby boomers. Publicly traded on NASDAQ, the company thinks of its job as “adding life to the Web.” Other Internet outfits offer customers the tools they need to load Web pages onto their PCs. Macromedia offers customers the software they need to make those pages dance, to get letters to hop, to enable cartoon figures to sing — the kind of performance pizzazz that lights up a Web surfer’s glazed eyes.

In a company that runs on techie know-how and intellectual property, Nelson fits right in: She may hold the title of CFO, but she is no narrow-minded bean counter: She speaks French, Portuguese, and Spanish, she studied at the Wharton Business School at the University of Pennsylvania, and she has worked for the World Bank.


Among Nelson’s biggest leadership challenges: assessing the value of projects like the New Way, an internal-investment strategy aimed at shifting much of Macromedia’s business onto the Web. Of course, the company is already all over the Web, where it mounts an awesome presence. But despite the company’s Web-savvy tools, it has yet to apply all of the Web’s most powerful lessons to its own business practices. Even today, 75% of Macromedia’s sales flow through distributors, dealers, and other indirect channels. So the company has set about building a new neighborhood in cyberspace, where business — everything from creating customer awareness to making sales to offering technical support — will flow through The New Way, Nelson says, is just that, a whole new way of dealing with customers on the Web.

The potential benefits are huge — and the potential costs of doing nothing, or doing the wrong thing, or of doing the right thing but doing it poorly or too slowly, are enormous. Fine. But what are the stakes exactly? In other words, when you’re a CFO in cyberspace, how do you do the math?

Discounting DCF

Nelson cut her teeth on asset valuation at Hewlett-Packard. She stayed at hp for eight years, the last four of which she spent evaluating acquisitions, equity investments, and strategic alliances. It was while working on mergers and acquisitions that she found the work that she loved.

“My interest is in the core drivers of value,” she says. To find those core drivers, Nelson sorts the components of any deal or investment into four “buckets”: market, product and technology, team, and financial. And to evaluate those components, she reaches back to a trusted tool in the CFO tool kit: discounted cash flow, a standard technique for projecting annual cash flow into the future and then discounting its value back to the present, taking into account the time value of money. “DCF analysis is still the touchstone,” she says.

But using DCF at Macromedia is very different from using it at hp. Granted, Nelson still reduces every idea to revenue streams: How much will come in and when? And she uses her cash-flow projections to calculate present value with a discount factor that shrinks the value of future cash flows in proportion to increased risk. But that’s where the similarities end. At Macromedia, Nelson uses this very traditional tool in very nontraditional ways, adapting DCF to the intangibles of the new economy.


Nelson takes the vagaries of intangible assets into account by conducting sensitivity, or “what if,” analyses. After carefully and systematically running the DCF numbers for Plan A, Nelson runs dozens of scenarios, generating alternatives, asking questions based on a broad set of changing assumptions, and poking holes in those assumptions. “When I was in graduate school, I used to take comfort in using a discount factor,” she says. “Isn’t that a great notion? It gives you a number, and that number lets you feel confident. But if all you do is use that black box of a discount factor, you haven’t addressed all the issues yet. They’re out there, but you don’t know what they are. They’re all embedded in your discount rate.”

What’s the New Way Worth?

In early 1998, with the executives at Macromedia growing concerned about the dramatic business changes being ushered in by the Web, Nelson came face-to-face with her own set of dramatic challenges. “The old multitiered distribution methodology was broken and getting worse,” says CEO Rob Burgess. To move all of the company’s customer contacts onto the Web, Burgess hired Stephen Elop to serve as senior vice president of the company’s Web division. Elop’s job: to answer all of the “how” questions. How could Macromedia enhance the customer experience at every point in the sales cycle? How, for example, could the company help a Web designer who was struggling with a specific animation problem? In effect, how could the company offer just-in-time training? At the same time, how could the Web help Macromedia learn more about each customer?

Elop and the executive team came up with a plan to generate Web pages on the fly that would suit each customer’s needs. A cartographer, for instance, would see cartographic content. The better the fit between content and customer, the longer the site would hold the customer. In developing the site, the company planned to use two key technologies: a “membership repository” that would profile each customer, and a BroadVision transaction engine that would allow Macromedia to target very specific customers.

All of which sounds smart and makes perfect Web sense, but it leaves one huge question unanswered: What is the New Way worth? To answer that question, Nelson and Elop agreed to measure the value of the project in three ways: marketing return on investment, the cost of sales, and share of customer loyalty.

The first measure, marketing ROI, shows the dollar return on money spent to acquire new customers. Marketing ROI increases with the ability to convert sales pitches into sales. It’s easy to calculate the costs and returns of using traditional direct mail. What Elop had to show was that the return on a Web campaign was much better than the return on a traditional campaign. That wasn’t hard to do, he says, because creating each additional electronic “piece” is incredibly cheap. What’s more, by using the Web to customize pieces, Macromedia could increase the customer-response rate.


The second measure, the cost of sales, simply shows the revenue that Macromedia could reclaim from the two or three tiers in its channels of distribution. In the past, the company’s costs would balloon as distributors took their share of sales margins. Costs also went up significantly as distributors held inventory in their pipelines. The New Way could slash those costs.

The third measure is Macromedia’s percentage of the money that each customer spends on Web-design products — in other words, loyalty, or “share of wallet.” “Ultimately, if we can increase customer loyalty, we know we can translate that into more revenue,” says Nelson. But how much revenue? The executive team grappled with that question for several months. “What’s the value of a customer relationship?” asks Nelson. “You don’t have a lot of hard data. You have to draw on a lot of gut in order to come up with the numbers that correspond to the market, the technology, and the ability of the team.”

Nelson finally did come up with numbers that reflected cost cuts, increased conversions, increased loyalty, and revenues from new products. In the end, she signed off on a $6 million spending program — money for new hires, consulting help, and hardware and software. “At the end of the day, it is a venture investment — high risk, high reward,” she says. “One thing that we know is that it’s extremely valuable to us to own that customer relationship.”

The most powerful lesson that Nelson has learned as a CFO is the importance of developing a soft analysis of hard numbers to measure value in the new economy. Long-term value still rises and falls on cash flow. And cash flow rises and falls on revenue. But revenue comes from a lot of intangibles these days — in particular, customer and consumer relationships. The challenge is to develop scenarios that, as much as possible, predict which revenue streams will pay.

Counting on Character

Ken Wilcox, 51, is not a textbook banker. If he were, he would lean on the same “5 Cs of credit” that every other banker uses to evaluate loans: character, capacity, capital, collateral, and cash flow. If he were, he would ask the people who work for him to hold on to one simple thought: Only cash flow repays loans. If he were, he would not work for Silicon Valley Bank.


When companies come to him for financing, Wilcox has a way of valuing them that’s different from the method that his peers rely on. It’s not that he doesn’t use the five Cs; he just looks at them from a different angle. Take capacity. Wilcox doesn’t look for profit-making records; he looks for the promise of an equity infusion. Or take collateral. He doesn’t look for plant and equipment; he looks for salable intangibles — intellectual property such as patents, or knowledge bases such as customer lists. “We don’t have tangible collateral,” he says.

Silicon Valley Bank wasn’t built on tangible collateral, and that’s rare among banks. With $3.5 billion in assets and 575 employees, SVB funds a lot of startups and young companies. It operates nationwide in three sectors: technology (including computers, software, semiconductors, communication, and online services), life sciences (biotech and medical devices), and a hodgepodge of special industries, premium wineries among them. For entrepreneurs, SVB is the blue chip of high-tech lenders.

One reason why Wilcox isn’t a textbook banker now is that he has never been one. He has always been faced with special cases, such as software companies that are trying to change the world. One SVB client, Scott Rozic, sells software for “intelligently automating the capture, organization, and discovery of information.” Few mainstream banks would touch Rozic’s company, Verge Software.

The problem goes to the heart of finance in the new economy: New companies don’t have tangible value. They have no history of revenue — let alone cash flow. They have no physical assets to sell other than rapidly depreciating computer hardware. Mainstream banks, finding no value to lend against, would never make loans to a business like Verge. So why would Wilcox be interested?

Safety without Cash Flow

Wilcox was never one to follow in others’ footsteps. He earned a PhD in German studies from Ohio State University and taught at the University of North Carolina at Chapel Hill. But he was smart enough at finance to figure out that rising inflation and his lagging professor’s salary meant that he was rapidly losing purchasing power. “I didn’t like being poor,” he says.


So in 1981, he sold all of his stuff, drove north, and enrolled at Harvard Business School. After Harvard, he went into high-tech lending. At the time, only about 100 people in the entire country even acknowledged that they would lend to high-tech, high-risk companies. In fact, the banking industry was structured to make lending to early-stage technology firms all but impossible. Banks were requiring all clients to hand over financial statements for the previous three to five years, and those statements had to demonstrate at least a couple of years of profitability and positive cash flow, as well as hard assets.

But a few bankers on either coast were learning that a company’s cash flow isn’t its only means of repaying loans. For example, a company could get cash from future equity investors. Or it could put up intangible assets as collateral. The old rules need not apply. Banks could create a new model for lending. “Making money safely means that we have to apply common sense to decisions,” says Wilcox. “If there is another way to make loans safely, we should do it.”

Over the years, as he built SVB’s East Coast business, Wilcox proved the validity of the new model again and again. His first principle: If necessary, equity investors can step in and use cash to repay a loan. The second: If investors don’t step in, SVB can find valuable — albeit intangible — assets to sell.

For example, in the early 1990s, when a client called Autographix went belly-up, its marketing-workstation technology was worthless: PC presentation software had surpassed it. But Autographix had one intangible of great value: a loyal customer base, complete with service contracts. SVB sold that asset for $6 million to NCR in Minneapolis.

Wilcox worked hard to refine his new model and to demonstrate its efficacy. And over time, SVB rewarded him for that work: He was elevated to chief banking officer and moved to Silicon Valley in 1997. Earlier this year, he became president, and he is a member of the executive committee that runs the bank. Nearly all of SVB’s loan officers and relationship managers report directly or indirectly to him.


The Code of Startups

Wilcox puzzles over the value of high-tech companies every day. What he’s learned from SVB’s experience over the years has given him a good fix on the factors that signal value in a client. Verge Software has the kind of value that Wilcox looks for. Working out of a small apartment in Colorado, Scott Rozic, 26, began developing a Web service that would help companies and individuals to structure and disseminate knowledge. As he sought (and obtained) funding from angel investors and technology partners, Rozic developed his own list of the measures that investors use to gauge value in Silicon Valley. “A lot of intangible value has been codified in Silicon Valley,” he says. Breaking that code and then showing that you know how to apply it are essential to securing long-term funding in the intangible economy.

Rozic goes through the list of measures that make up the Silicon Valley code. The first measure is target-market size: It should be at least $100 million. The second is proprietary intellectual property — in Verge’s case, patents that the company is seeking on its software. The third is a sales pitch that includes three key buzzwords: “viral,” “Internet,” and “monetize.” The fourth is the ability to partner with technology suppliers. And the fifth is a set of working relationships with world-class business partners in select fields: bankers, auditors, attorneys, and directors.

Rozic is a just-the-facts kind of guy: He not only knows the code; he knows how to use it to grade his own company. Take the fourth measure: technology partners. Verge has forged relationships with Autonomy, Inprise, Netscape, Microsoft, and Lotus. And there’s that all-important fifth criterion: world-class business partners. The company has three seasoned board members, including Stan Meresman, a former CFO of Silicon Graphics, and Mario Rosati, whose name is on the door at the high-powered Silicon Valley law firm Wilson Sonsini Goodrich & Rosati. Among its key advisers are four high-tech veterans, including John Luongo, a former CEO of Vantive, and David Peterschmidt, the current CEO of Inktomi Corp.

As Rozic goes down his list, it sounds like a lot of name-dropping. But Wilcox takes the name-dropping not as a sign of vanity but as a signal of value — as long as each name is a bona fide member of the company’s people network. “Deepening relationships,” Wilcox says, “is actually a way of mitigating risk.”

The Money Value of Time

In the world of Klaus Buechner, a 32-year veteran of Nortel Networks, a reliable dial tone once meant everything. That electronic purr symbolized the success of the company’s hardware, which was used to run telephone networks worldwide. Nortel’s new symbol of success is the Web tone, which the company creates by helping customers install Internet-protocol networks that can carry both voice and data.


The Web-tone vision has sent Buechner, 54, on a quest for assets that lie well beyond the borders of its traditional manufacturing base. As senior vice president of corporate strategy and alliances, he scours the globe for brainy engineers and breakthrough technologies that will help Nortel make the promise of the Web tone as much a reality as the dial tone used to be.

His preferred strategy: a full-tilt push to acquire the intangible assets that will put Nortel at the head of the pack. Last year alone, Buechner engineered four outright acquisitions and bought a minority stake in seven other companies. The biggest acquisition: Bay Networks, which Nortel bought for $6.9 billion. In the wake of that shopping spree, Buechner has thought a lot about what creates value and, in turn, what Nortel should pay for it.

“The value in Nortel is in the marketing, the techology, the R&D, and the solutions that we can provide for our customers,” he says. Hard assets — physical plant and manufacturing equipment — count for much less these days. Instead, one of the largest sources of value is the pool of ideas floating outside of the organization. In a world where companies compete on ideas, it’s not enough to look in-house; very often, the best minds reside elsewhere.

To illustrate this point, Buechner offers the example of Aptis Communications, a startup based in Chelmsford, Massachusetts. Aptis was founded in January 1997, when three engineers left Shiva Corp. to start their own company. Shiva makes remote-access servers for companies; Aptis began designing servers for telecom suppliers and developed an access switch that was capable of handling nearly three times as many dial-ins as the then-highest-volume modem on the market. Nortel’s Web-tone strategy made Aptis an appetizing acquisition target.

The question for Buechner: What was the value of Aptis? One rule of thumb that Buechner knew comes from John Chambers, CEO of Cisco Systems (an arch competitor of Nortel), who says that an acquisition is worth $2 million per engineer. Aptis had 40 engineers and no shippable product. Was it really worth $80 million?


Speed Counts

Just a few years ago, neither Buechner nor anyone else at Nortel paid much attention to the valuation of startups. The company designed products using its own corps of thousands of engineers. But Buechner and Nortel CEO John Roth concluded that small companies that were built to move quickly might pass Nortel in the Web-tone technology race. So Roth charged Buechner with carrying out a plan to pick up Nortel’s pace by using technology from outside the company.

Buechner was well prepared to take on this challenge. Born in Freiburg, Germany, he immigrated to Canada with his parents when he was eight years old. He attended college at Carleton University in Ottawa, Ontario, where he earned an electrical-engineering degree. In 1975, he became Nortel’s youngest-ever director of marketing. He then went on to hold other high-level positions at the company — including group vice president of Bell-Northern Research Inc., and managing director of Nortel’s German subsidiary.

But it was while doing a stint as group vice president of Nortel’s data-communications business that he learned the value of intangibles. In 1994, when Buechner took over that division, the data market was growing fast. (In fact, data traffic has since surpassed voice traffic on the world’s telecom networks.) But revenues from the datacom business were falling, and earnings were stalled.

Buechner zeroed in on the problem: In an industry where speed counts, Nortel’s research-and-development operation was bogged down. “We had too many engineers who were just trying to optimize the R&D,” he says. “They didn’t have a sense of what would make the business fly, and so we were in a start-stop mode.” Engineers kept reworking products every three or four months — which prevented them from getting to market. The result: no product, and R&D costs that shot through the roof.

To solve the problem, Buechner worked with engineers to refocus their efforts on product delivery. For one product line, he created two distinct development streams. In the first stream, engineers made incremental improvements to existing products. In the second, they developed the company’s next generation of products.


Almost immediately, Buechner’s approach proved the value of speed: Getting each product out fast pumped up sales. Within three years, revenues shot up from $250 million to $800 million. According to Buechner, 90% of those revenues came from small advances that sped improvements to market. At the same time, the company worked on developing future breakthroughs. Being first, Buechner says, brings huge benefits, even if “first” isn’t your absolute best.

Window Watching

That lesson about the value speed was foremost in Buechner’s mind when he assumed his current post in June 1997. The market rush toward Web-tone technology had begun to take off, far outpacing Nortel’s ability to develop internally all of the products that it would need. The market window had closed to a narrow slit. Buechner’s challenge: Grab technology before Alcatel, Cisco, Lucent Technologies, and other competitors did. “My objective,” he says, “was to be a significant change agent, to see if we could do something to take the blinders off Nortel.” As with R&D, the problem with acquisitions involved time: If Nortel could not be first with the products that its customers needed, then it would lose those customers. With that realization in mind, Buechner went on a tear, cutting deal after deal — one per month during his first 18 months on the job. That string of acquisitions and investments helped Nortel piece together key technologies for providing the Internet-protocol networks that Internet-service providers and global telecom companies all demand.

“The driving motivation for making an acquisition or taking a minority stake in a company is time to market,” he says. “If you’re not there at the beginning of a market window, if you’re not there to leverage the opportunity, your odds of being successful and becoming one of the top players — and therefore a profitable player in that market — are next to zero.” In other words, Nortel would pay handsomely for speed. Instead of thinking about the time value of money, Buechner was thinking about the money value of time.

Dealing in Time

When Nortel began to court Aptis in 1998, Buechner had nothing but time on his mind. The technology that Aptis had developed represented a major advance in an industry that had gone through three distinct market stages in rapid-fire order. In the first stage, makers sold their product — usually a box with 8 ports — to corporations. In the second stage, makers sold boxes with about 64 ports to Internet-service providers. But the third stage offered makers an immense new opportunity: to sell boxes with ports numbering in the thousands, boxes with the ability to deliver mind-boggling amounts of data and dial tone – like reliability, to ISPs and telecom companies. “The market became a different market,” says Buechner.

With that opportunity, though, came a problem: Nortel had a limited time in which to act — and no product. Yes, Nortel’s engineers were working on a product. So were the engineers at Shiva, one of Nortel’s strategic partners. But Aptis was far ahead of both companies. Says Buechner: “We had a hole in the dial-access business.”


Buechner and his team swung into action and devised a complex deal: Nortel severed relations with Shiva, it acquired an agreement with Shiva not to bar any former employees now working at Aptis from working on competing technologies, and it bought Aptis. When the deal was done, Nortel had access to technology that money wouldn’t be able to buy anywhere else for at least six months.

The acquisition, says Buechner, was all about time and people. “We bought a hard-core team of developers in that space,” explains Buechner. “As the value shifts to software and applications, more and more of the value of the company lies in its people, and less and less value lies in its assets. People really become the company, because that’s where the information is kept. I don’t care how well you document software and applications; ultimately, everything is in the minds of the people who developed it.”

But how to put a dollar figure on the technology in the minds of the engineers at Aptis? What was their lead time worth? And what was the value of the product’s architecture, which enabled the combination of voice and data? Buechner calculated the revenues that were likely to come from the sale of Aptis’s product through Nortel’s marketing and sales channels. He also ran a discounted-cash-flow analysis. But, like Betsey Nelson, Buechner recognizes the limits of DCF. “It’s useless,” he says. “Your ability to execute in terms of leveraging your channels, your ability to get the product to market, and your customer relationships are what will determine success.”

On the other side of the table, Aptis cofounder and CEO Paul Gustafson, 38, was also struggling to figure out the worth of his company. He came up with two methods. First, he looked at recent comparable initial public offerings on Wall Street. Second, he calculated Aptis’s likely future earnings, discounted them, and multiplied them by an old financial standby — the price-earnings ratio of comparable high-growth public companies.

In fact, Gustafson and Buechner were coming at the value of this asset from the same perspective: time. Like Buechner, Gustafson made the key assumption that the Aptis product would beat competitors’ products to market by six months. That would give Aptis — and Nortel — a big advantage in selling to telecom customers and a big head start on cash flow.

Ultimately, the two sides settled on $290 million — according to Gustafson, the largest amount ever paid for a technology company that had yet to ship a product and whose product was only 90% complete. True, UUNet and GTE had signed on to test the product. But, says Gustafson, “We hadn’t even proven it would work.”

Buechner was willing to pay the price for one reason: time to market. Nortel was able to ship a 20-inch-high access switch that could handle 1,344 calls simultaneously by summer 1998, roughly one year ahead of its competitors — a critical advantage for the company in executing its Web-tone strategy. Since the acquisition, Gustafson says, not only has Aptis delivered on time, but it has also widened its lead by 9 to 12 months. It even expects to deliver a new switch with 2,600 ports later this year — all of which has made Klaus Buechner one happy man. Says Buechner: “Market momentum is ultimately everything.”

Intangible Measures, Intangible Assets

Bob Boldt is a dyed-in-the-pinstripes investment manager. “My first job out of business school was investments,” he says. “That’s what I wanted to do, and it’s what I’ve done ever since.” In the 26 years since he left business school, Boldt, 50, has come to do investing in a big way, and, in the process, he has developed new ways to measure the value of intangible assets.

For the past two and a half years, Boldt has managed more than $140 billion in state-employee retirement assets for the California Public Employees’ Retirement System, the largest public pension fund in the United States. As part of his job as senior investment officer for global public-market investments, he oversees a domestic portfolio of roughly 1,700 stocks worth more than $100 billion.

His assignment with CalPERS has led Boldt to think about value in new ways. Part of that thinking stems from CalPERS’s approach to its investments: It owns a market basket of stocks, and it manages 75% of its holdings passively. It holds the best stocks and the worst ones; it doesn’t make rapid-fire trades to play the market.

Boldt approaches companies in which CalPERS has a position less as a speculator and more as an owner. His job, in essence, is to approach underperforming companies and to prod them to change in ways that will create value in the future. His goal is to educate them to think about the sources of a company’s value — about where their real assets lie and how those assets should be managed.

Atypical Approaches, Nontraditional Issues

Boldt knows all about analyzing stock values by using traditional methods. After earning his mba at the University of Texas at Austin in 1973, he went on to manage money for several banks in Chicago. That’s where, in 1981, he cofounded Concord Capital Management, which later moved its operations to San Mateo, California. Boldt managed institutional money for Scudder, Stevens & Clark from 1993 to 1996. A charter financial analyst, he won the Graham and Dodd Award in 1984, a prize for excellence in financial writing. (The award is named after Benjamin Graham and David Dodd, authors of the 1934 finance classic Security Analysis.)

But these days, Boldt has to come up with atypical approaches to dealing with nontraditional issues. He has the fiduciary duty to find every possible means of boosting the value of CalPERS’s portfolio. For Boldt, that doesn’t mean giving special attention to every stock: The portfolio is simply too big for that. Instead, he centers his work on the worst of the worst”on what are called “focus list” stocks.

Since the mid-1980s, CalPERS has named about 10 companies every year to its focus list. Recent entries on that list include Apple Computer, Advanced Micro Devices, Reebok, and Rollins Environmental Services. In looking at the list, CalPERS tries to find the most reliable indicators of each company’s ability — or, more important, its lack of ability — to perform. It then asks each company to take steps to improve its performance in those areas.

Over the years, this unique approach has moved William Crist, 60, an economics professor who heads the CalPERS board, to champion some cutting-edge notions. About 10 years ago, he led CalPERS in suggesting that modernizing the governance practices of a board of directors could improve a company’s performance. CalPERS’s argument: If the board is stacked with the ceo’s friends and family members, if it simply rubber-stamps the ceo’s ideas, then the entire company gets the message that “good enough” is good enough.

As logical as that idea sounds, it met with stony resistance from many big-company bosses, who didn’t agree that something as wildly intangible as governance practices could be used as an indicator of a corporation’s value-creating potential. “We were seen as intruders,” recalls Crist, “hostile aliens invading from somewhere.”

But Crist persisted. His hunch was that directorial independence, board practices that ensured accountability to shareholders, and other undeniably intangible factors were indeed indicators of long-term value. With that view in mind, CalPERS urged its focus-list companies to appoint a majority of independent directors, to forbid poison-pill takeover-protection plans, to pay directors only with stock and cash, and to evaluate their own and their CEO’s performance against written criteria.

The hunch paid off. CalPERS studies have since shown that companies that revamp their governance do, in fact, increase their value. The stock prices of 62 companies that were targeted by CalPERS as poor performers had trailed Standard & Poor’s 500 Index by 89% (14% per year) in the five years before CalPERS began badgering those companies. Within a few years of when the badgering began, those companies had outperformed the S&P’s average total returns by 23%.

For CalPERS, the presence of an enlightened board has become one of the strongest indicators of long-term value. That’s why every year, between November and March, Boldt spends 20% of his time talking to executives and board members at underperforming companies. Governance, that intangible factor driving performance, is the first topic that he brings up.

Enlightened Workplaces

In the early 1990s, CalPERS began to investigate another indicator of intangible value: enlightened workplace practices — for example, offering employees regular training, involving employees in corporate decision making, and linking employees’ pay to their performance. A 1994 report commissioned by the system concluded that companies that do a poor job of nurturing their human assets often do an equally poor job of protecting the value of their stock. The report went on to recommend that CalPERS consider using workplace practices as another criterion for selecting focus-list companies.

The system embraced the notion but stopped short of elevating it to the same level as board oversight. It remains a work in progress until Boldt and his colleagues can generate the hard data they need to link workplace practices to higher profits. “I can say unequivocally that having a strong board that is looking out for the interests of shareholders is good,” says Boldt. “I can say very few things unequivocally about workplace practices.” But, adds Crist, “workplace practices are still a consideration. I believe they will be emphasized more and more as we go along and refine them.”

The New Pay Package

Finally, Boldt has turned his attention to a third “soft” indicator of long-term value: pay plans that reward the real contributors of value-smart people. That simple notion accords with the evolving conditions of today’s economy. If people create most of the value in the new economy through their innovation and through customer service, then companies should pay those people in a way that motivates them to create more of that value. The question, Boldt says, is “How does management deal with the fact that it doesn’t own its own assets — it only rents them for a period of time each day?”

The answer? In a world where intellectual capital produces more value than financial capital, systems that foster the production of intellectual capital make a company worth more over the long term. For startups, the system of choice is the stock-option plan. “The ideal situation is a highly entrepreneurial company in which employees are compensated largely with stock and therefore feel attached to what’s happening to the company,” says Boldt. “If you’re a company starting up today and you can put yourself in that position, the sky’s the limit — and that’s what the stock market is saying.”

But CalPERS invests only a sliver of its portfolio in small firms. Most money goes to giants like Gillette and General Motors. Do options doled out in huge corporations stimulate the creation of intellectual capital? In fact, Boldt says, they function more as lottery tickets: “You can be rewarded for something that you had no part of, and you can be punished for something that you had no part of.”

It’s a lesson that Boldt learned during a stint at Texas Instruments, where he worked on an advanced computer project. At TI, he observed two kinds of engineers. The first, all fortysomethings, owned big chunks of stock; they had joined the company when ti was small. Working there was more than just a job — it was their financial future. Those engineers were willing to do whatever it took to make their projects work. They were committed to guarding TI’s future. They acted like owners because they were owners.

The second group of engineers, all twentysomethings — as Boldt was at the time — didn’t own enough stock to matter. The company had grown so large that their efforts wouldn’t make much of a difference in moving the stock price. And they held so few options that even if the company did do well, they wouldn’t enjoy substantial benefits. “There were no real incentives for me at TI,” Boldt says. The challenge for big companies today, says Boldt, is to create pay plans that give employees incentives, that generate both a sense of ownership and a feeling of leverage over the company’s performance. When companies do that, CalPERS views those plans as an indicator that their stock will pay off better in the long run. Once again, says Boldt, companies have to answer a key question: “How can I tie the well-being of the person performing a service directly to the financial product of his labors?”

Why Owners Act Like Owners

Boldt thinks that he’s found an answer to that question in a new application of an old measure. The measure is called economic profit, although it’s better known today as EVA, or Economic Value Added (a trademark of Stern Stewart & Co.). EVA is what’s left after you subtract a charge for the capital that a business unit uses (the weighted cost of capital multiplied by the amount of capital used) from earnings (specifically, net operating profit after taxes). Because EVA takes into account shareholders’ capital, many financial experts today believe that it offers a sharper picture of a unit’s true assets than the net income of the value produced by that unit.

EVA is essentially the income that a company earns above and beyond what its shareholders expect from investments of equal risk. Suppose you invest in a company, expecting that it will earn 15%. If the company does earn 15%, its eva is zero. If it earns more than 15%, its eva goes above zero. The corollary is that, as a company’s EVA climbs, its stock price climbs as well: Shareholders will bid up a corporation whose earnings exceed expectations — a corporation that “adds economic value.”

What Boldt likes about EVA is not the measure itself — which by now is old news. What Boldt sees in EVA is a tool that companies can use to link “Economic Value Added” to employees’ rewards. As companies create accounting systems to calculate the profit generated not only by the company as a whole but also by units within the company, it becomes possible to track the contributions that people make and to pay them accordingly.

“What really matters here is not just measuring EVA,” says Boldt. “The epiphany for me was how you can use it to offer incentives to people in a corporation to act like owners. It takes away the lottery effect in larger companies.” Like stock options, EVA-linked pay could reward individuals who come up with new ideas that help a company grow. “You can stretch EVA from the highest, most strategic decision in the corporation to the lowest tactical decision, and there’s integration,” says Boldt. “What EVA allows you to do is atomize your compensation system, so that you can get workers to think like owners. We need a good mechanism to align the interests of CalPERS with the interests of Joe in engineering. eva makes that link.”

Boldt’s linking of pay to corporate performance is simply the latest innovation in his ongoing effort to devise new measures for the new economy. Whether those measures relate to governance systems, workplace practices, or compensation methods, the challenge is the same: to accommodate an economy in which intangible assets — chief among them, the creativity and contributions of people — are critical to economic decision making.

Bill Birchard ( is coauthor of Counting What Counts: Turning Corporate Accountability to Competitive Advantage (Perseus books, 1999). He is also a contributing editor at CFO Magazine. visit the following organizations on the web: macromedia Inc. (, silicon valley bank (, Nortel networks (, and CalPERS (